Financial Stability Review
APRIL 2021
Financial Stability Review
APRIL 2021
Contents
Overview 1
1. The Global Financial Environment 5 Box A: The Transition Away from LIBOR 16 2. Household and Business Finances in Australia 23 Box B: Risks in Retail Commercial Property 32 3. The Australian Financial System 37 Box C: What Did 2020 Reveal About Liquidity Challenges Facing Superannuation Funds? 48 4. Domestic Regulatory Developments 53 5. Copyright and Disclaimer Notices 59 The material in this Financial Stability Review was finalised on 8 April 2021 and uses data through to 8 April 2021.
The Review is published semiannually and is available on the Reserve Bank's website (www.rba.gov.au). The next Review is due for release on 8 October 2021. For copyright and disclaimer notices relating to data in the Review, see the Bank's website.
The graphs in this publication were generated using Mathematica.
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For the full copyright and disclaimer provisions which apply to this publication, including those provisions which relate to Excluded Material, see the RBA website. Overview
Financial systems globally have been provision balances are expected to be sufficient resilient to a substantial shock to absorb the impact of future defaults. Financial systems in Australia and internationally Globally, ongoing fiscal stimulus, the rollout of have been resilient to the enormous COVID-19 COVID-19 vaccines and very accommodative health and economic shock. This has enabled financial conditions are contributing to the them to cushion the economic impact of the economic recovery that started in the second pandemic, supporting the recovery through half of 2020. There is still substantial new lending and measures such as loan underemployed labour and capital, but the repayment deferrals. The financial sector reforms strong rebound in economic activity greatly that followed the global financial crisis greatly reduces the risk of a sustained deep global contributed to this positive outcome. Banks hold recession that would be very damaging for substantially more high-quality liquid assets and financial institutions. Accommodative financial have much higher levels of capital than a conditions, including policy interest rates that decade ago. Substantial policy support from central banks have committed to keep very low governments, central banks and other regulators for several years, and expectations of a sustained has also underpinned the resilience of the recovery in activity in most economies, have financial system over the past year. Fiscal contributed to rising asset prices, and support has sustained economic activity and indebtedness in some sectors. If risk premiums improved the finances of borrowers, and so loan were to rise from low levels, then long-term performance, and central banks have eased bond yields could jump higher, leading to falls in monetary policy and maintained market a broad range of asset prices that are liquidity in key debt markets. Financial regulators underpinned by the low level of risk-free interest have also employed flexibility in the regulatory rates. framework, for example by providing temporary capital relief if banks extended payment Key risks to financial stability are similar deferrals to customers affected by the in Australia and internationally pandemic. The Australian banks are in a strong financial An incomplete, or very uneven, economic position coming out of the pandemic. Their recovery would present risks to financial stability profitability recovered in the second half of 2020, after banks increased their provisioning for If incomes remain below pre-pandemic levels in expected loan losses in the first half, and analysts some countries, as government support is expect profitability to strengthen further in 2021. wound back, it increases the likelihood that Banks’ non-performing loans have increased, but some borrowers will struggle to make their debt by less than expected, and their current repayments, exhaust their financial buffers and consequently default. Slower growth would also
FINANCIAL STABILITY REVIEW – APRIL 2021 1 impede the ability of banks that had low premium is more in line with its value in recent profitability before the pandemic – in particular years. Housing prices in many economies have some in Europe and Japan – to generate new been rising, at a faster pace from the second half capital, and so weigh on their resilience to losses of 2020, which has mitigated the risk earlier in and willingness to lend. Delays in widespread the pandemic that falling prices would result in vaccination, or a reduced efficacy of available significant losses on mortgage lending. In vaccines, are a crucial factor that could stall the Australia, housing prices have recorded strong economic recovery. But even if the recovery in growth in recent months. To date the growth in aggregate activity proceeds broadly as asset prices has not been associated with a expected, an uneven recovery with some parts significant increase in the growth of debt. of the economy continuing to be constrained by However, globally risks associated with asset the virus would still cause significant losses for prices and debt could build. A sustained period lenders exposed to those sectors. of rising asset prices may lead to over- Some emerging market economies (EMEs) are exuberance and extrapolative expectations, with exposed to risk from tightening in financial increased risk-taking and leverage in an conditions in advanced economies, particularly environment of accommodative financial if their own recovery is lagging. Historically, conditions. In this situation lending standards financial dislocation in EMEs has coincided with could weaken, with asset prices being pushed rising global interest rates. In addition, slower above their fundamental values. A correction in rollout of vaccines and pre-existing asset prices, if borrowers’ income were to fall macroeconomic and financial imbalances are and so they defaulted on debt repayments, impeding the recovery in some EMEs, with would expose lenders to large losses on the output not expected to return to pre-pandemic increased debt, particularly if the quality of that levels for several years. These EMEs could then debt had been eroded. face sharp capital outflows, exchange rate The risks are higher from some specific depreciations or unhelpful increases in their leveraged assets. In a number of economies, domestic interest rates. Sharp financial including Australia, housing price growth (and adjustment and disruption in large EMEs could to a lesser extent housing borrowing) has picked also result in losses for exposed investors and up notably in recent months and is being financial institutions in advanced economies. watched closely by regulatory authorities. Globally, the pandemic has accelerated Cyclically low interest rates and rising asset structural change in the retail sector, including prices create a risk of excessive borrowing increasing online sales, leading to falling retail A range of asset prices, both globally and in commercial property prices, while demand for Australia, have been rising – a channel through office property is uncertain given changing work which expansionary monetary policy stimulates practices. The pandemic has also created more economic activity – and some appear high specific challenges for some types of assets. For relative to their expected future stream of example, in Australia, the decline in immigration income. However, for most financial and real and preference changes has introduced assets, this lower rate of expected earnings additional uncertainty for apartment prices, relative to the asset price is broadly consistent particularly in inner city areas. with the very low level of interest rates. For In an environment of accommodative financial example, for equities while the price-earnings conditions with rising asset prices it is ratio is high in some markets, the equity risk particularly important that there is not excessive
2 RESERVE BANK OF AUSTRALIA risk-taking by the financial sector. Increased risk- system or critical nodes. Given this, it is crucial taking by lenders could take the form of looser that financial institutions and systems not only lending standards for individual loan take preventative actions, but enhance resilience assessments, or a relaxation of internal limits on by planning recovery actions to cyber security the share of riskier loans they make. Even if breaches. lenders do not weaken their own settings, increased risk-taking by optimistic borrowers could see a deterioration in the average quality of new lending. This would weaken the resilience of businesses and households, and so the financial system, to future shocks. Increased risk-taking would fuel rising debt, from already high levels, increasing the debt-related risks to the economy and financial system from a fall in asset prices and borrowers’ income. The improvement in lending standards in Australia for property from the mid 2010s helped to ensure borrowers were well placed to weather the economic shock over the past year, demonstrating the benefits to the financial system and the economy of appropriately controlling risks.
Cyber attacks are a growing risk for financial stability Over the past 6 months there have been several high-profile cyber attacks worldwide. While financial institutions were not specifically targeted by these attacks, some were affected. These attacks have demonstrated the increased sophistication of perpetrators. Financial institutions globally typically rate cyber as one of the most substantial risks they face. Large financial institutions, which are more systemically important, have the scale for substantial investment in cyber security. However, with a very large and increasing number of attacks, there remains the likelihood that even large financial institutions or critical financial market infrastructure will at some point be impacted, including via third-party providers. Substantial cyber attacks could risk financial stability if, for example, they corrupt significant data or if they affect large parts of the financial
FINANCIAL STABILITY REVIEW – APRIL 2021 3
4 RESERVE BANK OF AUSTRALIA 1. The Global Financial Environment
The global financial system has been resilient to funds. Global bodies, as well as national the increased uncertainty and sharp economic regulators, are also working on ensuring an contraction induced by COVID-19. Setbacks to orderly transition away from London Inter-bank the economic recovery, such as further virus Offered Rates (LIBOR), a key global interest rate outbreaks or delays in the rollout of effective benchmark that is being discontinued (see vaccines, are a risk to global financial stability. ‘Box A: The Transition Away from LIBOR’). In The economic recovery is expected to be slower addition, policymakers have resumed their work in some emerging market economies (EMEs), as addressing longer-term risks to the financial a result of slower vaccine distribution and pre- system, including those associated with climate existing economic and financial imbalances. A change. slower recovery in EMEs could expose them to sharp capital outflows and higher interest rates Prolonged economic weakness and an than the state of their economies warrant. uneven recovery are key risks to The prices of financial assets and housing have financial stability continued to increase and are at high levels in a The unprecedented policy response by govern- number of economies, raising the potential for ments, central banks and other policymakers is increased borrowing, including to take contributing to global economic activity advantage of expected capital gains. Such recovering from the largest contraction since activity can cause asset prices to overshoot the immediate aftermath of the Second World fundamentals and increase vulnerabilities to any War. Progress on vaccine development and subsequent sharp asset price falls. A jump in rollout has also underpinned expectations for long-term bond yields, for example from an strong economic growth in the next 2 years. For abrupt reassessment of the risk of inflation, now, however, employment is well below pre- could lead to disruptive falls in asset prices. Most pandemic levels in many economies. banks are well positioned for higher credit losses The recovery and hence risks to financial stability because they have strong capital and liquidity remain dependent on the extent of any new positions. However, large unexpected losses virus outbreaks, and the timely and widespread associated with a stalled recovery would test the distribution of effective vaccines. In the near ability of some banks to maintain credit supply. term, financial stress for households and Internationally, policymakers remain focused on businesses would rise if the recovery were to assessing the ongoing effects of the pandemic, falter. Financial institutions would also face larger sharing information and coordinating actions to credit losses than currently expected, which mitigate its impact. A renewed focus is could hinder the recovery through tighter addressing risks in the non-bank financial financial conditions. In addition, a setback to the institution (NBFI) sector, including investment recovery could also trigger disruptive falls in
FINANCIAL STABILITY REVIEW – APRIL 2021 5 asset prices. Over the medium term, a sluggish especially technology stocks. High equity prices recovery would keep financial stability risks reflect low long-term interest rates, with equity elevated given the high level of debt in many risk premiums around where they have been for economies and areas of fragility in some much of the past decade (Graph 1.1). Also financial systems. contributing to the high level of equity prices is The economic recovery in some EMEs is that while corporate earnings fell sharply, by projected to be slower than in advanced 20 per cent in the United States, they are economies as a result of pre-existing economic expected to make a strong recovery. and financial imbalances, more limited fiscal Nonetheless, there are a few segments with high support and a slower rollout of COVID-19 valuations relative to traditional pricing metrics, vaccines. Financial stability risks associated with including some technology companies and the pandemic will therefore be more persistent some smaller companies in the United States, in EMEs. Rising government bond yields in where there has been a sharp increase in retail advanced economies will then present a trading activity. While leverage among retail dilemma for some EME central banks between investors remains low, recent events around the supporting their domestic economies with low hedge fund Archegos highlight that highly- policy rates, or raising policy rates to prevent leveraged and opaque investments in a small capital outflows. This dilemma would be number of assets can lead to significant losses compounded if government bond yields were among financial market participants. to rise substantially in advanced economies due Spreads between yields on corporate bonds and to an increase in the risk of higher inflation. sovereign bonds have narrowed to pre- There are signs of some capital outflow pressure pandemic levels, including for very low rated in South Africa, Turkey and some South borrowers (Graph 1.2). Low interest rates are an American countries. important factor driving this, which was Financial conditions could even tighten in some previously assisted by purchases of corporate advanced economies if their economic recovery bonds by some central banks. The compression and inflation expectations lag those in the in spreads is despite an increase in corporate United States, where there is a very large fiscal bond defaults and credit downgrades, which are stimulus. This is because government bond expected to increase further. Risks in corporate yields in other economies tend to move with credit markets had already been increasing in those in the United States, and so yields would likely rise in other advanced economies (absent a policy response). Graph 1.1 Equity Valuations ppt index Equity risk premia* US earnings and GDP** Equity and corporate bond prices November 2019 = 100 indicate an optimistic outlook 11 120 Europe Progress on vaccines, expectations of additional 8 90 Nominal GDP stimulus in the United States and sustained low 5 60 interest rates have supported a further rise in US Earnings financial asset prices. Major equity indices are on 2 30 average about 15 per cent higher than their -1 0 level before the pandemic. The rebound 2002 2012 2022 2002 2012 2022 following large falls early in the pandemic has * 1/(forward PE ratio) minus real risk-free rate ** Dashed lines indicate market forecasts been particularly strong in the United States and Sources: Consensus Economics; IMF; Refinitiv
6 RESERVE BANK OF AUSTRALIA the lead-up to the pandemic. Credit ratings March 2020.[2] International regulators, including declined (particularly in the investment grade through the Financial Stability Board (FSB), are market) and lending standards in leveraged loan working to address these vulnerabilities as part markets weakened.[1] Issuance volumes have of a broader work program to address risks in also been strong. Since March 2020, firms in the NBFIs.[3] United States and euro area have issued almost US$2 trillion of corporate bonds, about Housing prices and credit growth are 30 per cent more than in the previous year. also rising in many economies The large rise in asset prices could encourage Housing price growth has increased in many increased borrowing to take advantage of economies since mid 2020, in part reflecting expected capital gains. This would increase the expectations that interest rates will remain very risk from disruptive corrections in prices. Such a low for an extended period (Graph 1.3). Price correction could occur if government bond growth accelerated in the latter part of 2020 and yields were to increase sharply, including if there in recent months annualised rates of growth is a sudden rebound in inflation expectations were 5 per cent in the United Kingdom, and if investors demand more compensation for 15 per cent in Norway, 20 per cent in Sweden uncertainty. This risk has been partly realised and the United States, 30 per cent in Canada, recently, as inflation expectations increased in and 40 per cent in New Zealand. In addition to the United States with the recent passage of an low interest rates, housing demand has been additional large stimulus package, though boosted by government policies that have inflation expectations are not elevated. In late supported household income and directly February, the increase in yields was exacerbated increased housing activity. Higher housing by low liquidity in government bond markets. prices improve households’ balance sheets, The illiquidity was not as severe as in the turmoil increase economic activity (via the wealth effect of March 2020 and did not generally spill over to and activity associated with building and selling other asset markets. housing) and mitigate near-term risks that banks Investment funds have the potential to amplify will incur significant losses on mortgage lending. asset price declines given the leverage and Increases in housing prices have been liquidity risks at some funds, with these risks accompanied by stronger credit growth, contributing to the market dislocation seen in resulting in rising household indebtedness,
Graph 1.3 Graph 1.2 Housing Price Indices Corporate Bond Spreads January 2017 = 100 To government bonds with equivalent maturity index index bps bps Investment grade Non-investment grade 140 140
600 2,250 New Zealand 130 130 US Euro 120 120 400 1,500 Canada US 110 110 UK 200 750 100 100 Australia Sweden Norway 90 90 0 0 2017 2019 2021 2017 2019 2021 2001 2011 2021 2001 2011 2021 Sources: CoreLogic; CREA; Eiendom Norge; Nationwide; REINZ; S&P Sources: ICE Data used with permission; RBA Global; Valueguard
FINANCIAL STABILITY REVIEW – APRIL 2021 7 including in economies where household debt The New Zealand Government and the RBNZ was already high such as Canada, New Zealand have recently implemented several policies and Sweden (Graph 1.4). Declines in lending designed to deliver more ‘sustainable’ housing standards would accentuate risks to financial prices, including by dampening investor stability from a fall in housing prices and demand to help improve affordability for first household income. home buyers. In March 2021, the RBNZ In New Zealand, housing price growth has been reinstated the LVR restrictions that had been in widespread across the country. Housing credit place prior to the pandemic. LVR restrictions will growth has also increased, reflecting higher be further tightened from May so that no more growth in lending to both investors and owner than 5 per cent of banks’ new mortgage lending occupiers, including first home buyers. Growth to investors can be at LVRs above 60 per cent. in investor credit increased sharply after the In addition, the New Zealand Government has Reserve Bank of New Zealand (RBNZ) removed directed the RBNZ to consider the impact on loan-to-valuation ratio (LVR) lending restrictions housing prices when making monetary and at the start of the pandemic. These restrictions financial policy decisions. The RBNZ’s financial had limited banks’ high-LVR lending: for policy will take into account the government’s investors to 5 per cent of new lending at LVRs objectives. The Monetary Policy Committee’s above 70 per cent and for owner occupiers to targets will remain unchanged, but the RBNZ 20 per cent of new lending at LVRs above will outline the effect of its monetary policy 80 per cent. The share of loans with LVRs decisions on the government’s objectives. The between 70 and 80 per cent held by investors New Zealand Government has also increased from 3 per cent before the loan implemented several other policies, including restrictions were removed, to a peak of extending the period in which investors have to 10 per cent in October 2020, but then decreased pay capital gains tax after selling a property to to 7 per cent in January 2021. Rents have also 10 years (from 5 years), the removal of interest been rising at a faster rate than overall inflation deductibility for investors and measures to for several years, consistent with long-running increase housing supply. housing supply constraints and demand for To date, few other jurisdictions have housing that was partly driven by an increase in implemented policies to address risks in housing population growth from mid 2019 to early 2020. markets. Authorities in Korea announced several measures to increase housing supply, including Graph 1.4 building 1.5 million properties over the next Mortgage Credit 4 years, allowing housing to be built on govern- Year-ended growth % % ment property (such as military sites) and Sweden New Zealand relaxing building height limits. The Canadian 7.5 7.5 Australia government intends to implement a nation- 5.0 5.0 Canada wide tax on foreign property purchases (British
2.5 2.5 Columbia and Ontario have their own taxes) and US the Bank of Canada Governor has stated there 0.0 0.0 are preliminary signs of ‘excess exuberance’. -2.5 -2.5
-5.0 -5.0 2012 2014 2016 2018 2020 Sources: Federal Reserve Bank of St. Louis; RBA; Reserve Bank of New Zealand; Statistics Canada; Statistics Sweden
8 RESERVE BANK OF AUSTRALIA Risks are elevated in industries most States, and those with a slower recovery in affected by the pandemic and for small corporate earnings, are more vulnerable to businesses significant rises in corporate defaults and Corporate indebtedness increased over 2020 in insolvencies going forward. advanced economies, including among the While earnings in some industries picked up in lowest rated borrowers, supported by the second half of 2020 in line with the accommodative financial conditions. Much of economic recovery, earnings are expected to this borrowing was to increase firms’ liquidity remain weak in the consumer discretionary and buffers, and some firms began to repay these industrials (includes airlines and airport services) funds over the second half of last year. Defaults sectors. The energy sector has been supported in the corporate bond market and credit rating by stronger oil prices recently, with prices downgrades have increased over the past year, around 60 per cent higher than their level in but remain below their global financial crisis October 2020, but its earnings outlook remains (GFC) levels in both the United States and uncertain and highly dependent on the pace of Europe (Graph 1.5). However, defaults are the economic recovery. These 3 sectors account expected to increase further over 2021. for a considerable amount of debt at a higher The increase in corporate stress that is evident in risk of default as their ability to service debt rising bond defaults is yet to be seen in banks’ deteriorated significantly over 2020 (Graph 1.6). non-performing loans (NPLs) due to Parts of the commercial real estate (CRE) sector moratoriums on bank loan repayments and have also been especially hard-hit by the insolvencies, and other support for businesses. pandemic. Delinquency rates in the US Business failures fell in 2020 despite large commercial mortgage-backed securities market contractions in economic activity; in most OECD remain relatively high despite having fallen from economies there were around 10 to 30 per cent their peak in June 2020. Delinquency rates are fewer insolvencies in 2020 than in 2019. around 16 per cent for hotel loans and However, insolvencies started to pick up in the second half of 2020 in the euro area. Advanced Graph 1.6 economies that experienced rapid growth in Advanced Economies – Non-financial Corporates* corporate debt prior to the pandemic such as % % Changes in EBITDA Debt at Risk**
Canada, France, Switzerland, and the United 0 25 2019 2020 -10 20 Graph 1.5 -20 15 High Yield Corporate Default Rates* Share of defaulting companies by number, 12-month rolling average -30 10 % %
-40 5
-50 l l 0 * * y y s s s s y y s s 10 10 e e l l l l a a * * r r t t t t g g e e * * a a l l a a r r a a a a i i r r i i o o t t r r r r p p e e n n e e t t s s T T e e a a n n o o s s h h t t t t e e i i t t t t E E u u s s a a l l e e O O d d r r a a r r M M n n e e e e c c I I s s R R i i m m d d u u s s US r r n n 5 5 e e o o m m C C u u s s n n o o C C Europe * Includes 10,528 companies from Australia, Canada, UK, US, and 15 developed European countries 0 0 ** 2005 2009 2013 2017 2021 Share of total debt from companies with interest coverage ratio below 1 *** ‘Other’ includes utilities, information technology, health care, and * By domicile of parent company communication services Source: S&P Global Market Intelligence Sources: RBA; S&P Global Market Intelligence
FINANCIAL STABILITY REVIEW – APRIL 2021 9 12 per cent for shopping mall loans. Market- distress. Banks have therefore been able to based valuation indicators, including the prices continue to lend to households and businesses, of real estate investment trusts (REITs) and although conditions for new lending to small property indices, indicate that there have been businesses and some sectors most affected by falls in the value of retail, hotel and some office the pandemic have tightened considerably. properties in a number of countries. This is Advanced economy banks’ profitability generally especially so in countries dependent on tourism increased in late 2020 (Graph 1.7). Provisions for such as France, Italy and Spain. Some REITs face expected losses decreased significantly in most liquidity risks as they will be exposed to margin jurisdictions as the likelihood of a very severe calls if CRE valuations decline and cause their and persistent global economic contraction has gearing to breach covenant limits. Valuation moderated. In addition, regulatory stress tests in metrics in Australia have also fallen for retail and major jurisdictions continue to indicate that office property (see ‘Box B: Risks in Retail most banks will be able to withstand losses Commercial Property’). implied by severely adverse scenarios without Globally, small and medium-sized enterprises breaching minimum regulatory capital (SMEs) appear more vulnerable in the near term requirements. Therefore, many banks have been than larger businesses. SMEs are able to resume, or announced plans to resume, disproportionately in service industries more payments to shareholders that were partly constrained by the pandemic, and they also halted by regulators last year to strengthen generally have lower liquidity buffers and more banks’ capital positions. limited options for obtaining funding. This is Banks’ NPLs to date have not increased particularly the case since lending standards significantly because of the policy response, have tightened for SMEs in many economies. As including loan repayment deferrals, loan a result, SMEs have relied more on bank guarantees and job support programs. But these forbearance and government-guaranteed loans support measures have started to unwind and to assist them through the pandemic. Loan most of those remaining are scheduled to wind forbearance and some other temporary support back or expire this year. The share of loans with measures have already been, or will soon be, loan repayment deferrals has fallen from the unwound in many economies, which will lead to peaks in mid 2020 in major jurisdictions, an increase in insolvencies and banks’ reported SME NPLs if the recovery in activity is not rapid. Graph 1.7 Large Banks’ Profitability and Capital* Globally, banks have been resilient to % % Return on equity CET1 capital ratio 2019 rising credit losses, but some would be Canada 2020 20 16 tested by large rises in defaults US
The regulatory reforms implemented following 10 12 the GFC have been important in enhancing Japan banks’ resilience. The median of advanced 0 8 Euro area economy banks’ Common Equity Tier 1 (CET1) -10 4 capital buffers increased by around UK -20 0 n a a 7.5 percentage points between the GFC and the K S a d 2008 2014 2020 e U U r p a a a n J a o
start of the pandemic. The policy responses to r C u the pandemic have also boosted household and E * Number of banks: Canada (6), euro area (33), Japan (4), United Kingdom (4) and United States (12) business cash flow and so limited their financial Sources: RBA; S&P Global Market Intelligence
10 RESERVE BANK OF AUSTRALIA particularly for housing loans. To date, the Japanese banks to take on substantial holdings performance of loans that have come off of offshore leveraged loans and collateralised repayment deferrals has generally been positive. loan obligations (CLOs), which are vulnerable to Large Canadian, UK and US banks have reported price falls. However, most of the CLO tranches that around 90 per cent of loans for which held by Japanese banks are AAA-rated and most deferrals expired have been performing. banks intend to hold them through to maturity, However, delinquencies at small businesses mitigating the risk of trading losses. remained elevated towards the end of 2020 in Since the onset of the pandemic, euro area the United States. banks’ holdings of their home government’s Risks are higher among many euro area and bonds have increased on average by around Japanese banks. On average, banks in these 20 per cent. Deposits have increased given fiscal jurisdictions have provisioned less for expected stimulus payments to households and credit losses than their peers, and the European businesses, reduced opportunities for spending Central Bank has raised concerns about under and increased caution. With weak credit provision (Graph 1.8). Euro area and Japanese demand, banks have invested in the increased banks’ willingness to continue to lend would be supply of sovereign bonds. Euro area tested if loan defaults rise by more than corporations have also issued govern- currently anticipated. ment-guaranteed bank loans, particularly in Banks in the euro area and Japan also tend to France and Spain. Both of these factors have have low underlying profitability and equity increased euro area banks’ vulnerabilities to any valuations, partly because of overcapacity and concerns about sovereign debt sustainability. the extended period of low domestic interest rates. The return on equity for euro area and Financial stability risks in China remain Japanese banks prior to the pandemic was elevated, despite the strong economic around 4–5 per cent, relative to 11 per cent in recovery Australia and the United States. In addition, There are some long-running vulnerabilities in Japanese banks serve an ageing and shrinking China’s financial system that authorities have domestic population, which reduces growth been working to address. These include opportunities. Lower margins have induced elevated levels of corporate debt, weak capital positions among many smaller banks, an opaque and undercapitalised shadow banking Graph 1.8 system with strong links to the banking system, Large Banks’ Loan Impairment Expense and widespread perceptions of implicit public Half-yearly, per cent of gross loans* sector guarantees. The strong policy response % United States United Kingdom % 2.25 2.25 (starting with containing the virus), and the
1.50 1.50 associated economic recovery, have largely
0.75 0.75 contained financial risks for now. Several instances of stress among individual financial % Euro area Canada % 2.25 2.25 institutions (including prior to the pandemic)
1.50 1.50 have not spread to the broader financial system. 0.75 0.75 However, some of the measures taken by 0.00 0.00 authorities to boost economic activity have 2010 2015 2020 2010 2015 2020 * Number of banks: United States (10), United Kingdom (4), euro increased medium-term vulnerabilities. area (30), Canada (6) Sources: RBA; S&P Global Market Intelligence Corporate debt increased over the past year to
FINANCIAL STABILITY REVIEW – APRIL 2021 11 around 165 per cent of GDP, as regulators seeking to reduce risks in the real estate sector encouraged corporate borrowing, in contrast to by instituting a ‘three red lines’ policy, which their pre-pandemic efforts to slow credit growth places increasingly strict restrictions on debt (Graph 1.9). While this borrowing was largely raising by property developers. However, real from banks and the bond market (rather than estate companies have proved adept in the past NBFIs, also known as ‘shadow banks’), risks of at circumventing new regulations designed to financial stress emerging from the corporate reduce risks. sector remain elevated. Defaults on corporate China’s large banks remain well capitalised and bonds have risen, including by some state- profitable – on average their CET1 capital ratios owned enterprises (SOEs). These SOE defaults are around 12 per cent. Concerns continue to partly reflect the weaker financial position of focus on smaller banks with low capital buffers, some local governments and attempts by low provisions, poor asset quality and weaker authorities to wind back implicit guarantees. governance and risk management (Graph 1.10). Local government debt has also risen, including These vulnerabilities have been exacerbated by among the more indebted provinces, with the response to the pandemic, including record bond issuance of CNY4.6 trillion mandating an increase in bank lending to micro (US$700 billion) by provinces in 2020 to fund and small enterprises at favourable interest rates. stimulus expenditure. Local governments’ use of Regulators have allowed 2 small banks to issue bonds instead of off-balance sheet entities has perpetual bonds to address their capital increased transparency, but the stock of off- deficiencies, while in Liaoning authorities have balance sheet debt remains high. announced that 12 of the province’s The economic recovery has allowed authorities 15 commercial banks will be merged into a to resume their focus on lowering financial single bank following NPL issues. More generally, stability risks. This includes reducing risks in the in keeping with the trends of recent years, shadow banking system with measures such as Chinese banks are being encouraged to dispose tighter standards for trust investments and a of NPLs to improve the health of their balance widely expected targeted reduction of sheets. outstanding trust loans by CNY1 trillion (US$150 billion) in 2021. Authorities are also
Graph 1.9 Graph 1.10 China – Non-financial Sector Debt* Per cent of nominal GDP China’s Banking System % % By sector By type % Return on equity CET1 capital ratio % Shadow financing 19 13 Bank loans State-owned* Bonds Aggregate 200 200 14 10 Total
% Loan loss provisions Distressed loans** % Per cent of distressed loans Share of loans Corporate 100 100 100 8 Joint-stock Small Government** 70 4 Household 0 0 40 0 2008 2014 2020 2008 2014 2020 2012 2016 2020 2012 2016 2020 * Includes RBA estimates of shadow financing that is not included * Break for state-owned banks in 2015 reflects the change to internal in total social financing ratings-based approach for risk-weighted assets ** Includes some borrowing by local government financing vehicles ** Includes non-performing loans and special mention loans Sources: BIS; CEIC Data; RBA; WIND Information Sources: CEIC Data; RBA; S&P Global Market Intelligence
12 RESERVE BANK OF AUSTRALIA Conditions in EMEs have generally while the slower rollout of vaccines and pre- improved but financial stability existing financial and economic imbalances are challenges remain likely to lead to a slower recovery in some EMEs The improvement in EME financial conditions than in advanced economies. Many EMEs are since mid 2020 has come alongside the recovery not expected to achieve widespread vaccination in economic activity and global trade. Yields on until at least the end of 2022. Several major local currency government bonds remain low EMEs, including Brazil, South Africa and Turkey, relative to pre-pandemic levels for most EMEs, entered the crisis with macroeconomic and despite rising in recent months, while spreads financial imbalances. Given these challenges, on US dollar-denominated bonds have generally GDP in most EMEs will remain below pre- continued to narrow towards pre-pandemic pandemic trajectories. With a faster recovery and levels (Graph 1.11). In this low interest rate so rising bond yields in advanced economies, environment, EME sovereigns and corporations more vulnerable EMEs will face pressures of have issued significant amounts of local capital outflows, exchange rate depreciation and currency and US dollar-denominated debt. This rising domestic interest rates, which would has raised the level of indebtedness for EMEs hamper the domestic recovery. If capital and placed pressure on domestic banks, which outflows became disorderly, confidence in have absorbed much of the local currency investments in EMEs could be undermined and issuance. This increase in debt has also increased result in broader contagion. currency risk where the debt denominated in EMEs in east Asia are generally better placed to foreign currency is unhedged, and the risk of manage these risks. They entered the COVID-19 capital outflows where local currency or crisis with relatively strong macroeconomic US dollar debt have been purchased by foreign fundamentals and banking systems, have investors. generally had better health outcomes than The pandemic is continuing to pose challenges other EMEs, and have since benefited from the for EMEs, despite the improvement in financial recovery in global trade and industrial conditions. The resurgence of COVID-19 at the production. However, banks’ ability to extend end of 2020 has constrained economic activity, credit may become constrained as measures, such as the delayed recognition of NPLs, are unwound. In India, the Reserve Bank of India Graph 1.11 expects bank NPLs to rise from 7.5 per cent in Emerging Markets – Financial Conditions % Government bond yields* Equity prices** index September 2020 to 13−15 per cent by 8 150 Latin America Asia*** September 2021 (Graph 1.12). Indian banks are 7 125 also exposed to deteriorating asset quality at 6 100 5 75 NBFIs, which have increased their share of funding from banks (from 34 to 37 per cent) index Exchange rates** Cumulative flows to funds**** % (against the US dollar) Europe, Middle East 100 3 and Africa since the COVID-19 crisis began and have 90 0 received 10 per cent of banks’ non-food credit
80 -3 outstanding.
70 -6 M J S D M M J S D M 2020 2021 2020 2021
* Local currency bonds; weighted by market value ** 1 January 2020 = 100 *** Excludes China **** Per cent of assets under management; includes flows to bond and equity funds Sources: Bloomberg; EPFR Global; IMF; JPMorgan; MSCI; RBA
FINANCIAL STABILITY REVIEW – APRIL 2021 13 The global financial sector faces these costs and any related financial stability ongoing challenges, including from risks. To aid this, the FSB recently published a cyber risks and climate change toolkit of effective practices for financial [5] Cyber incidents pose a significant threat to the institutions’ cyber incident responses. The FSB stability of the global financial system. The is currently assessing the scope for convergence incidence and costs of cyber attacks are in the regulatory reporting of cyber incidents. increasing. In the past 6 months there have been Climate change and the transition toward a low- large-scale, high-profile attacks – including carbon economy pose longer-term risks to Accellion, Microsoft Exchange and SolarWinds – financial institutions.[6] In November, the FSB that have impacted financial institutions as well published a report on these risks, finding that as other entities globally (domestic implications there are channels through which the effects of are discussed further in ‘Chapter 3: The realised physical and transition risks for financial Australian Financial System’). These events have institutions could be transmitted and amplified, highlighted the potential for large-scale including across borders.[7] These included asset sophisticated attacks. The International fire sales, pro-cyclical reductions in bank lending Monetary Fund has estimated that direct losses and insurance provision, and reduced sovereign from cyber attacks could be as large as creditworthiness. 9 per cent of total bank net income globally.[4] Globally, policy work on climate change is Efficient and effective responses to, and recovery progressing in a number of areas, and support from, a cyber incident are essential to limiting has broadened with the recent decision by the United States to re-join the Paris Agreement. The Graph 1.12 FSB and the Network of Central Banks and Banking Sector Non-performing Loans Supervisors for Greening the Financial System Share of loans (NGFS) are exploring ways to promote high % % Non-Asian EMEs Asian EMEs quality climate based data and disclosure
India 9 9 requirements. The FSB and NGFS have also Russia planned work on assessing, and closing, data
6 6 gaps to ensure that regulators and investors Turkey Thailand Brazil have sufficient data to evaluate climate risks. A Indonesia 3 3 recent Taskforce on Climate-related Financial Malaysia Disclosures (TCFD) implementation report Argentina South Africa 0 0 highlighted progress on TCFD-aligned 2011 2016 2021 2011 2016 2021 disclosures by firms. Sources: CEIC Data; IMF
Endnotes [1] FSB (Financial Stability Board) (2019), ‘Vulnerabilities COVID-19 Pandemic’, Financial Stability Review, April, associated with leveraged loans and collateralised pp 14–19. loan obligations’, December. Available at [3] FSB (2020), ‘Holistic Review of the March Market
14 RESERVE BANK OF AUSTRALIA
FINANCIAL STABILITY REVIEW – APRIL 2021 15 Box A The Transition Away from LIBOR
For several decades, London Inter-bank LIBOR is not a viable benchmark for Offered Rates (LIBOR) have been a widely interest rates used benchmark for global interest rates, LIBOR seeks to measure the interest rates that underpinning derivatives, loans, bonds and large banks offer to lend to each other on an other financial products. The UK Financial unsecured basis in the London short-term Conduct Authority (FCA) estimated in money market.[2] It is calculated as the January 2021 that LIBOR underpinned average of submissions from a panel of banks around US$260 trillion of derivatives and published by ICE Benchmark Adminis- [1] contracts globally. However, LIBOR has tration (IBA), which is regulated by the FCA. notable deficiencies as a benchmark. Given LIBOR rates are calculated for 5 major this, regulators globally determined that currencies with tenors ranging from LIBOR cannot be relied on beyond 2021 and overnight to 12 months. markets need to transition to more robust LIBOR has several weaknesses, which became and reliable market-determined interest rate more apparent with the global financial crisis benchmarks. of 2007-08. In particular, some market A smooth LIBOR transition is recognised by participants had, for many years, been the G20 and the Financial Stability Board manipulating LIBOR to benefit their financial (FSB) as a key international regulatory priority. institutions. Benchmark reforms and A disorderly transition would create regulation have addressed this. However, significant risks for banks and other financial concerns remained over the reliability and and non-financial firms, and for the financial robustness of LIBOR. In 2017, the FCA system more widely. Market participants, expressed concern that wholesale funding with strong regulatory encouragement and markets were not sufficiently active or liquid support, are already transitioning to for LIBOR to be calculated based on alternative benchmarks so that they are ready transactions. In the absence of transactions, for the cessation of LIBOR by the end of 2021. panel banks can make submissions based on Progress is greatest for larger financial ‘expert judgement’.[3] However, banks institutions and derivatives markets. However, became increasingly reluctant to make such LIBOR transition is less advanced in other submissions given the uncertainty around markets, such as loans, which affect a broader providing estimates when there is little or no range of firms, including corporates, and market activity, owing to the risk of being where much remains to be done to be ready associated with benchmark manipulation. for the end of LIBOR. In 2017, the panel banks agreed with the FCA to voluntarily sustain LIBOR until end 2021 to limit the financial stability risks from a disorderly end to LIBOR. Over recent years,
16 RESERVE BANK OF AUSTRALIA banks, other market participants and There would be a lengthy period of costly regulators have been jointly working on litigation to resolve ambiguities. If such transitioning away from LIBOR. The market contracts are widespread this would turmoil at the onset of the COVID-19 undermine confidence in some systemically pandemic in early 2020 added impetus to important markets, and could affect the the transition. The already limited number of supply of credit to the real economy. There is market transactions underpinning LIBOR fell also a risk that firms are not operationally even further so that these rates were almost ready for the transition away from LIBOR, entirely based on expert judgement.[4] even if they have agreed to alternative rates. Following an IBA consultation, the FCA This lack of readiness in systems and announced on 5 March 2021 that all LIBOR processes could mean that correct payments settings will cease at the end of 2021, with are not made, which would prove disruptive the exception of several heavily used USD if many firms are facing operational LIBOR tenors (overnight and one, 3, 6 and difficulties. 12 month) which will cease at the end of In addition, there is a risk of unethical, June 2023.[5] The extended dates for the USD inappropriate or unlawful behaviour, and LIBOR tenors aim to ‘allow most legacy USD resulting penalties, in the transition away LIBOR contracts to mature before LIBOR from LIBOR. In particular, clients could be experiences disruptions’, as there are transferred to rates that disadvantage them challenges associated with transitioning or to inferior contractual terms, or their these contracts to alternative reference products may become unsuitable or not rates.[6] Similarly, the FCA is considering perform as expected. Regulators whether there is a need to further extend the internationally have been providing publication of a limited number of LIBOR guidance on conduct risk to support settings in an amended form to support institutions in transitioning away from LIBOR. legacy contracts for which substituting Appropriate mitigation strategies include a another interest rate is exceptionally difficult risk management framework that covers the (‘tough legacy’ contracts).[7] Nonetheless, LIBOR transition, as well as an effective and regulators globally have reiterated that the transparent communications policy. use of all LIBOR settings in new contracts Domestically, the Australian Securities and must cease after 2021. Investments Commission (ASIC) released guidance in November 2020 on practices A disorderly transition away from that Australian entities can adopt to manage LIBOR is a risk to financial stability conduct risk during the LIBOR transition.[8] When publication of LIBOR ceases, firms that are parties to contracts still referencing LIBOR Much remains to be done by the end without robust fallbacks in place (discussed 2021 deadline for LIBOR below) will face considerable risks. For these LIBOR transition is a major focus of the G20’s contracts, it may be unclear what the new financial reform efforts, involving the FSB, interest rate should be, or one or more other international bodies, national counterparties to a contract may view the regulators, benchmark administrators and chosen new rate as being unreasonable. market participants.[9] The key elements of
FINANCIAL STABILITY REVIEW – APRIL 2021 17 Table A1: Alternative Reference Rates replacing LIBOR Currency Alternative rate US dollar Secured overnight financing rate (SOFR) Euro Euro short-term rate (€STR) Japanese yen Tokyo overnight average rate (TONA) or TIBOR Sterling Sterling overnight index average (SONIA) Swiss franc Swiss average rate overnight (SARON) Source: FSB
this work have been to replace LIBOR with Where it is not feasible to replace LIBOR with alternative reference rates in contracts, and in an alternative reference rate in existing the case of existing contracts where it is not contracts (e.g. where multiple security feasible to amend the reference rate, to holders would need to agree to the change), include the fallback rates to apply when it is important that robust fallback provisions LIBOR is discontinued. are included in the contract so that it is clear National bodies have identified (nearly) ‘risk- what rate will apply when LIBOR ends. Many free rates’ (RFRs) to replace LIBOR in the contracts have fallback clauses, but these are 5 major currencies (Table A.1). Despite the often cumbersome to apply, involve significant transition efforts to date, LIBOR is significant discretion and could lead to still the dominant benchmark in new global substantial market disruption when LIBOR contracts.[10] A broad indicator of trading ends. activity across derivatives markets in the For derivatives, the International Swaps and 5 LIBOR currencies (plus the Australian dollar) Derivatives Association (ISDA) has developed shows increasing adoption of RFRs, but it robust fallbacks for LIBOR and other IBOR- remains at a low level (Graph A.1). referenced contracts, using the RFR benchmarks plus a spread.[11] These new ISDA fallbacks for derivative contracts came Graph A.1 into effect on 25 January 2021, meaning they have been included in all new contracts that Interest Rate Derivatives* Percentage referencing risk-free rates reference ISDA’s standard interest rate % % definitions from that date. Over 10.0 10.0 13,500 entities across more than 85 jurisdictions have adhered to the fallbacks 7.5 7.5 protocol, meaning their existing contracts
5.0 5.0 relying on ISDA definitions will also include the fallbacks, thereby facilitating a smooth 2.5 2.5 transition when LIBOR ends.
0.0 0.0 S D M J S D M J S D M However, there are coordination challenges 2018 2019 2020 2021
* Percentage of activity across all interest rate derivatives (IRD) that is in developing robust fallbacks for other transacted in RFRs each month; it covers USD, EUR, JPY, GBP, CHF and AUD IRD contracts LIBOR-referenced products outstanding, such Source: ISDA-Clarus as bonds and loans. Work is currently
18 RESERVE BANK OF AUSTRALIA underway across industry to progress LIBOR hold bills as a source of funding and to transition in these markets, but much manage their liquidity, and a wide range of remains to be done. These markets, which wholesale investors purchase bills. Moreover, involve a broad range of financial and non- the methodology underlying the benchmark financial firms, present financial stability risks calculation has been strengthened in recent with the end of LIBOR if they are not moved years. BBSW, unlike LIBOR, will not end and onto new reference rates. market participants will be able to choose to Under the FSB’s Global Transition Roadmap, base contracts on BBSW or the cash rate firms should have been in a position to offer (Australia’s RFR). However, there is little non-LIBOR linked loans to their customers at issuance of one-month bank bills. At this the end of 2020 and have adhered to the tenor BBSW largely represents the repurchase ISDA Fallbacks Protocol by its effective date of by banks of their bills that have one month to 25 January 2021. By mid 2021, firms should maturity. Given this tenor is less liquid, users have established formalised plans to amend of one-month BBSW should consider using legacy LIBOR contracts to reference alternative benchmarks. alternative rates where this can be done, and While BBSW remains a robust benchmark it otherwise have discussed with was included in ISDA’s Fallbacks Protocol for counterparties the steps needed to prepare derivatives contracts as a matter of prudent for the use of alternative RFRs for LIBOR- risk management. Fallbacks provide an linked exposures that extend beyond 2021. important contingency for financial contracts Authorities are taking steps to support based on any reference rate. The fallback rate limited legacy contracts that are particularly for BBSW is the overnight cash rate plus a difficult to transition from LIBOR. spread based on the historical difference Over coming months, the transition away between BBSW and the cash rate. In the from LIBOR to RFRs will need to accelerate future, the Reserve Bank will be requiring with further adoption of ISDA fallback contracts that reference BBSW to include provisions so that the industry is ready for the robust fallback provisions in order to be cessation of LIBOR by the end of 2021. eligible collateral in its open market Globally, regulators are coordinating and operations. The implementation of this monitoring progress closely, and taking requirement is being determined with input action as required to ensure that risks are from industry. appropriately managed. Notwithstanding the robustness of BBSW, LIBOR transition is nonetheless a key priority Australia has adopted a multiple-rate in Australia. LIBOR contracts are still a approach for domestic substantial component of banks’ and other reference rates firms’ exposures in Australia due to the The bank bill swap rate (BBSW) is the main international nature of their activities. At the domestic credit-based benchmark, and end of 2020, the aggregate notional LIBOR remains robust. This is because, unlike LIBOR, exposures of major Australian financial there are enough transactions in the local institutions was around $8 trillion. Progress is bank bill market. Australia has an active bank being made, however, with LIBOR exposures bill market as the 4 major banks issue and declining overall for the key Australian
FINANCIAL STABILITY REVIEW – APRIL 2021 19 financial institutions over the course of 2020. in particular, that they meet the LIBOR But exposures still rose at some individual deadlines. ASIC and the Reserve Bank have institutions. strongly advised Australian institutions to Given these sizeable exposures, financial adhere to the ISDA Fallbacks Protocol, and regulators strongly encourage and support expect institutions to work towards meeting the transition away from LIBOR.[12] The the timeline for LIBOR transition readiness set Australian Prudential Regulation Authority out in the global transition roadmap and and ASIC are monitoring progress on LIBOR ceasing the use of LIBOR in new contracts [13] transition by the entities they regulate, and beyond the end of 2021. In the remaining working with institutions as required to months of this year, firms should work ensure adequate progress in transition and, intensively on ensuring a smooth transition away from LIBOR by the end of 2021.[14]
Endnotes [1] See Schooling Latter E (2021), ‘LIBOR – are you LIBOR Benchmarks’, 5 March. Available at ready for life without LIBOR from end-2021?’,
20 RESERVE BANK OF AUSTRALIA
FINANCIAL STABILITY REVIEW – APRIL 2021 21
22 RESERVE BANK OF AUSTRALIA 2. Household and Business Finances in Australia
Concerns of widespread financial stress in the the near term given changes in housing household and business sectors have eased as preferences and reduced immigration. The economic outcomes have exceeded expec- short-term risks of oversupply of apartments are tations. Improving economic conditions and limited by the relatively low volume of expected temporary policy measures have supported apartment completions in 2021. households’ and businesses’ cash flows, allowing Conditions in the office property market remain almost all to make debt repayments and most to weak, with vacancy rates having increased maintain or even grow their liquidity buffers. considerably over the past year, particularly in This has in turn reduced the risks of large scale Sydney and Melbourne. Risks from the retail defaults on housing and business debt. property sector are elevated, given weak rental The vast majority of households and businesses market conditions. However, the financial who had deferred loan repayments have now positions of the largest owners of retail property resumed full repayments. However, some remain sound, and they appear well placed to increase in household and business financial cope with the ongoing structural change stress is likely as temporary support measures towards online retailing. In contrast, some progressively end and borrowers deplete smaller landlords might have greater difficulties financial buffers. Households and businesses in managing declines in earnings, and that derive their incomes from sectors most insolvencies are likely to rise (see ‘Box B: Risks in heavily affected by the pandemic face an Retail Commercial Property’). elevated risk of repayment difficulties if their buffers prove to be insufficient. Overall though, Overall, household finances have the share of heavily indebted households and improved … businesses in this position is small. As a result, Household disposable income increased by lenders’ non-performing loan ratios are 5 per cent over 2020, boosted by temporary expected to rise modestly from low levels. government income support. Improving labour The nature of risks in housing markets has market conditions contributed to income changed over the past six months. The growth in the second half of the year. The economic recovery and policy stimulus have program to allow households to access their underpinned strong demand for housing, superannuation early also provided a notable particularly from first home buyers. Housing boost to household cash flow, with 3.5 million prices in the largest cities have risen to be withdrawals totalling $36 billion (3 per cent of around 2017–18 levels. However, the price aggregate annual household disposable increases have not been uniform by region or income) until the program’s conclusion at the dwelling type. Demand for inner city apartments end of 2020. The combination of higher fell over 2020 and is likely to be constrained in household disposable income and a sharp
FINANCIAL STABILITY REVIEW – APRIL 2021 23 decline in household consumption saw the have the additional safety net of large mortgage household saving ratio double to 12 per cent prepayment buffers. Around half of all over 2020. This additional saving was used to mortgages have prepayment buffers equivalent pay down debt and/or build liquidity buffers, to more than 3 months’ worth of repayments with the aggregate household mortgage debt- and, for more than one-quarter of loans, the to-income ratio declining over 2020, and buffer exceeds 2 years’ worth of repayments household deposit balances rising relative to (Graph 2.3). The share of loans with prepayment household disposable income. (Graph 2.1). Part buffers of only one month or less fell very of the increase in household deposits has been slightly over 2020 and remains close to its pre- in the mortgage offset accounts of indebted pandemic level of 40 per cent. Most loans with households. low prepayments do not present large risks to Survey data suggest that the increase in liquidity lenders. Data from the Reserve Bank’s buffers (the ratio of bank deposits to expenses) Securitisation System suggest that just under has been evident for both renters and indebted two-thirds of these loans are held by investors homeowners (Graph 2.2). Households with and/or fixed-rate borrowers who have incentives members employed in a range of industries – to hold savings outside their mortgages. Of the including those that have been relatively heavily remaining loans with low prepayments, some affected by the pandemic – have also increased are new loans that have not yet built buffers, their buffers. In contrast, outright homeowners – while others belong to borrowers with who are typically less likely to encounter persistently small prepayment buffers. This latter financial stress than other types of households – group of relatively ‘risky’ borrowers has declined have reduced their buffers, though they remain to around 10 per cent of all loans from around high relative to other households, who are 15 per cent a year ago. potentially more vulnerable. Timely survey data indicate that households who rented or had a mortgage were much more … but a small share of households are likely to access some form of (government or vulnerable private) financial assistance in 2020 compared to Most households remain in a good position to outright owner-occupiers (Graph 2.4). service their debt given low interest rates and Households with at least one member working
Graph 2.1 Graph 2.2 Household Liquidity and Debt Household Liquidity Buffers Share of household disposable income* Ratio of bank deposits to monthly expenses, median* % % months months
Gross housing debt** 75 150 6 15 Deposits
Deposits net of 50 125 Indebted homeowner** offset accounts 4 10 Outright homeowner
Mortgage prepayments*** Housing debt net of 25 100 mortgage prepayments*** 2 5 Renter
0 75 0 0 2010 2015 2020 2010 2015 2020 2017 2019 2021 2017 2019 2021 * Before housing interest costs * Monthly expenses include living expenses, loan, and rental payments; ** Gross of redraw and offset account balances six-month moving average *** Sum of redraw and offset account balances ** Includes households with investor and owner-occupier debt Sources: ABS; APRA; RBA Sources: RBA; Roy Morgan Single Source
24 RESERVE BANK OF AUSTRALIA in industries that remain heavily affected by the of 11 per cent in May 2020. Almost all borrowers pandemic (the recreation and personal, whose repayment deferral has come to an end – transport and storage, and retail sectors) were including many who chose to resume payments slightly overrepresented among those seeking early – have resumed full repayments and are up assistance. Looking ahead, some of these to date with their loan schedule. The small households may need to draw on their number of loans still on deferred payments are prepayment buffers as support is unwound. slightly skewed towards borrowers with riskier The share of housing loans (by value) on characteristics, such as those with high loan-to- repayment deferrals at the end of February valuation ratios (LVRs) at origination and with 2021 had declined to 0.7 per cent, from a peak prepayment buffers of less than 3 months’ worth of repayments (Graph 2.5). Loans remaining on deferral are at greater risk of entering arrears Graph 2.3 than those that have already exited repayment Housing Loan Prepayments* deferral arrangements. A disproportionate share % % Share of loans outstanding Share of total housing lending is in Victoria, where the recovery had been February 2021 delayed. However, any rise in housing loan Owner-occupier Investor 40 20 arrears rates over coming months is likely to be more modest than previously expected given better-than-expected economic conditions (see 20 10 ‘Chapter 3: The Australian Financial System’).
Housing market strength has reduced 0 0 1 4 3 2 4 2 1 2 ≤ ≤ 2012 2016 2020 near-term risks to household > ≤ ≤ o t o o t t 1 3 2 > balance sheets 1 > > Months of prepayments Housing market conditions have strengthened * Available redraw plus offset account balances Sources: APRA; RBA as the economic recovery has continued (Graph 2.6). Accommodative monetary policy has supported the prices of housing and other Graph 2.4 Selected Financial Assistance during COVID-19 Share of households by tenure, self-reported, February 2021* Graph 2.5 % Renter Indebted owner Outright owner % (28%) (29%) (39%) Deferred Housing Loans % Loan characteristics Loan performance % 15 15 February 2021 Share of loans exiting deferral 100 100
10 10 75 75
5 5 50 50
25 25
0 * * * 0 y y y s s s n t t t l l l * * * o r r r e e e o b b b t * * * i i i i r r r t t t t a a a e e e i i i d l l l e e e c e e e i i i d d d t t t e h h h u l l l y r r r t t t * * * l u u u h d a a a e e e * * * c n O O O r r r e t n n n p p p e e e i r o o o o o o o c c c - u u u 0 0 f f f t t w s s s s a 0 0 s s s n n n n r r r s t i s n n n August 2020 – February 2021 a a a r 9 9 e e e e e s t t t r o o o w w w n r i i i s s s p p p t t t o R a a a o i i i > ≤ / / / h e e r r r c c c t t l t s s s e e e d d d u u u n a s s s R R c c c c i n r i h h h d d d m a a a r n n n t t t i i i V V e e e o e y a a a V f r r r R R R L L W W W a e u u u m < s s s D p n n n 0 3 I I I e r 8 < p * The share of respondents by housing tenure is shown in parentheses ** Reduced or put on hold insurance or personal loan payments Share of all loans Performing Extension Share of deferred loans Repaid in full Non-performing *** The survey asks if respondents receive any other types of financial assistance; JobKeeper is self-reported under this question Restructured Sources: RBA; Roy Morgan Single Source Sources: APRA; RBA
FINANCIAL STABILITY REVIEW – APRIL 2021 25 assets. After falling by almost 2 per cent Australia’s international borders is expected to between April and September 2020, nationwide cause population growth in 2021 to be around housing prices have since more than recovered. 1¼ percentage points lower than previously In Perth and Darwin, prices have been expected and has reduced demand for inner city increasing for the first time in several years, rental housing by international students. A shift although they remain around 20 per cent below in preferences towards detached houses has their peaks of 6–8 years ago. In Sydney and also been weighing on demand for inner city Melbourne, prices are now a little above the apartments. However, near-term risks of historical peaks they reached in 2017/18 . oversupply – and therefore sharp price declines Housing demand has been supported by low – are mitigated by the considerably smaller interest rates, stimulus payments boosting volume of higher-density inner city apartments household income, temporary additional due for completion in 2021 relative to previous support for first home buyers and the years. HomeBuilder program. If housing prices Rising housing prices have reduced the continue to rise as the end of stimulus payments incidence of negative equity. The share of loans slows household income growth, this will for which the value of the loan exceeds the present renewed challenges for housing value of the property has fallen to around affordability for lower income households. 1¼ per cent, down from over 3 per cent a year While prices have been rising nationally, there ago (Graph 2.8). As a result, a larger share of have been important compositional differences. borrowers could sell their property and These differences reflect changes in preferences, extinguish their debt if they experienced and the composition of demand, in response to repayment difficulties, reducing potential losses the pandemic. Prices in regional areas have for lenders. The share of loans in negative equity increased by 11 per cent over the past year, has fallen in all states, but the incidence remains compared to 5 per cent in the capital cities. Price greater in Western Australia, the Northern growth has also been stronger for detached Territory and Queensland. Loans that remain on houses than for units. Rental conditions have repayment deferrals are no more likely to be in also been weak, particularly in Melbourne and in negative equity than those making full the inner and middle suburbs of Sydney where repayments. vacancy rates have increased sharply and rents for units have fallen (Graph 2.7). The closure of
Graph 2.7 Graph 2.6 Housing Market Conditions Seasonally adjusted Housing Prices % Sydney units* Melbourne units* % Seasonally adjusted, January 2014 = 100 index index 30 30 Prices Advertised rents 15 15 Canberra 150 150 Sydney 0 0 Hobart 125 125 % % Melbourne Sydney vacancy rates** Victoria vacancy rates** 6 6 Regional Brisbane Adelaide Inner Melbourne 100 100 4 4 Middle Perth Darwin 2 2 75 75 Outer Other 0 0 2008 2014 2020 2008 2014 2020 50 50 * Apartments and townhouses; six-month annualised growth 2017 2021 2017 2021 ** Rental market vacancy rate for all dwelling types; quarterly Sources: CoreLogic; RBA Sources: CoreLogic; RBA; REINSW; REIV
26 RESERVE BANK OF AUSTRALIA Lending standards are largely loans have similar prepayment buffers and unchanged and remain robust arrears rates. While new loans are generally at The strengthening in lending standards since higher risk of facing repayment difficulties in the the mid 2010s has ensured that indebted event of a shock to household income than households generally had sufficient income and older loans, there is little evidence to suggest equity buffers to cope with the COVID-19 that lending to first home buyers has been an economic downturn. Lending standards were especially risky form of lending. initially tightened further at the onset of the Credit growth has increased but remains modest pandemic in anticipation of deteriorating and has mostly been driven by lending to economic conditions, but with the subsequent owner-occupiers (Graph 2.11). Some of the improvement in the economic outlook, this has increase in owner-occupier loan commitments since been unwound. The share of high LVR has been related to a pull-forward of demand for lending increased over the second half of construction loans, which may ease with the 2020 but remains low by historical standards, expiry of the government’s HomeBuilder while the share of interest-only lending has been program. Investor credit growth has increased in little changed at low levels (Graph 2.9). The share recent months but remains very low by of lending at high debt-to-income ratios also increased over the second half of 2020 following Graph 2.9 earlier declines (Graph 2.10). ADIs’ Housing Loan Characteristics* Some of the increase in high LVR lending to Share of new lending % Total Owner-occupier Investor % owner-occupiers reflects the greater share of 20 20 first home buyers who have responded to LVR>90 LVR≥90 government incentives and lower interest rates, 10 10 which make purchasing housing more attractive % % relative to renting. Despite typically having Interest-only 60 60 higher initial LVRs than other borrowers, prior to 30 30 the pandemic first home buyers tended to pay Interest-only (share outstanding)** down their debt relatively quickly. In addition, 0 0 2013 2020 2013 2020 2013 2020 Securitisation System data suggest that for loans * LVR series break at March 2018 due to reporting changes; interest-only series are break-adjusted and seasonally adjusted less than 5 years old, first home buyer and other ** Share of outstanding interest-only loans to housing credit Sources: APRA; RBA
Graph 2.8 Graph 2.10 Housing Loans in Negative Equity Debt-to-income Ratios Share of total balances Share of new lending, quarterly % % % % Total Total Owner-occupier Investor WA & NT QLD Other 3 3 4 ≤ DTI < 6 40 40 DTI < 4
2 2
20 20 1 1 DTI ≥ 6
0 0 0 0 2016 2017 2018 2019 2020 2021 2018 2019 2020 2018 2019 2020 2018 2019 2020 Sources: ABS; CoreLogic; RBA; Securitisation System Sources: APRA; RBA
FINANCIAL STABILITY REVIEW – APRIL 2021 27 historical standards. Investor loan commitments, Improved trading conditions and policy support which are a leading indicator of investor credit have helped businesses maintain the large cash growth, have started to rise, and lenders have buffers they accumulated in 2020 (Graph 2.13). reported renewed investor interest, particularly By late 2020, companies’ holdings of cash and for detached houses. deposits covered more than 5 months’ worth of expenses on average, while unincorporated Business profitability has improved as businesses had over 2 months’ worth of buffers. the economy has started to recover While this partly represents firms reducing In aggregate, business profitability has recovered expenses, it is mostly accounted for by increased strongly following the significant trading cash holdings. In addition, some businesses hold disruptions that occurred at the height of the committed lending facilities with banks that pandemic, with temporary policy measures they could draw on if needed. These savings are providing significant support (Graph 2.12). expected to support businesses through the Aggregate business revenue remains weaker recovery. than a year ago, but this has been more than matched by reductions in operating expenses. Despite improvements in the outlook, some businesses are vulnerable in the near term Graph 2.11 Businesses in the arts and recreation, Housing Credit % % Loan commitments* Credit growth** accommodation and food, and transport sectors have experienced relatively large declines in 1.2 15 revenue over the past year (Graph 2.14). Activity Owner-occupier 0.8 10 in these sectors remained at a low level in late 2020 even as aggregate economic conditions 0.4 5 Investor improved. A sizeable share of firms in these Total sectors have continued to receive a significant 0.0 0 boost from temporary support measures in early -0.4 -5 2021. 2009 2015 2021 2009 2015 2021 * As a share of total housing credit; excludes refinancing ** Six-month-ended annualised terms Some firms will find it challenging to continue to Sources: ABS; APRA; RBA meet their existing expenses as the policy
Graph 2.12 Graph 2.13 Aggregate Business Profitability Cash Holdings of Non-financial Businesses % Change in revenue and expenses % Year-ended Months of expenses 10 10 months months
0 0 5 5 Revenue -10 -10 Corporates Expenses* 4 4 % Change in profits % Year-ended 3 3 4 4 Unincorporated enterprises 2 2 2 2
0 0 1 1 -2 -2 2004 2008 2012 2016 2020 0 0 * Estimated as the difference between revenue and gross operating 2004 2008 2012 2016 2020 profits Sources: ABS; RBA Sources: ABS; RBA
28 RESERVE BANK OF AUSTRALIA support measures are withdrawn if their trading with average trade credit payment times – an conditions do not improve. As at February 2021, indicator of firms’ difficulty in making payments the share of businesses still receiving JobKeeper – slightly below pre-pandemic levels. The failure payments was highest in Melbourne and in of trade finance investor Greensill Capital in areas with a relatively high share of businesses March does not appear to reflect broader operating in sectors more affected by the problems with the provision of trade credit in pandemic (Graph 2.15). Firms in these sectors Australia or internationally. also tend to be more highly geared and have Overall, the risks of insolvency appear largest for lower levels of liquidity than those in other SMEs operating in high risk industries, given they sectors, suggesting they face a higher risk of tend to have smaller cash buffers and have been future difficulties in servicing their debts. more reliant on temporary support measures Without a sustained pick-up in revenue, some than larger firms. The share of SME loans with businesses will be forced to reduce their current deferred repayments has fallen to just over one levels of employment. In turn, this will diminish per cent (by number), from around 13 per cent the ability of some households to service their in June 2020. The share of major banks’ SME own debts. lending with a relatively high probability of In addition, many businesses provide, or rely on, default has increased, suggesting that banks trade credit (where a business purchases goods expect the performance of some SME loans to or services on account and pays the supplier at a deteriorate. later date). If some businesses have trouble making their payments, this would spill over to Business insolvencies have begun to rise other businesses through trade credit networks. Business insolvencies have risen from their To date, these contagion risks remain contained, mid-2020 lows, with the increase at the very end of the year coinciding with the end of the moratorium on director liability for insolvent Graph 2.14 trading (Graph 2.16). Looking ahead, it is likely Business Revenue and that insolvencies will rise further for some JobKeeper Payments by Industry* % Revenue growth, December quarter 2020** % months, notwithstanding the expected 20 Year-ended 20 10 Quarter-ended 10 0 0 Graph 2.15 -10 -10 JobKeeper Payments % JobKeeper as a share of revenue*** % By Statistical Area 4 (SA4) region* *
Firms that received payments in February 2021, median * % 40 40 s e i r t s
30 30 u d n
i Sydney 30 20 20 d e t c e
10 10 f f a - c 0 0 i t . r s s s g n e e n e g r m i l t o e e e e
n 20 o d n o e i a i i c a h c c c m t t r a t p i i i d s n e r i c l d s Melbourne s u t v v v n e O t l r r r u e e n l A a M t r i c o e e e l t a p a a r s s s h s a t f & n l T n e i e u c d W a a o n i e R o s R n r a d C o o m f i e 10 r & M i s f & m s s f t . . e r
o Others f o m f A o e r r n m I a P o h c S c 0 A 0 5 10 15 % * Non-financial businesses in industries from the ABS Quarterly Share of firms receiving JobKeeper in February 2021 Business Indicators Survey * There are around 100 SA4 regions in Australia, each comprising ** Industry aggregates; quarter-ended growth rates are seasonally between 100,000 and 500,000 residents; a small number of regions adjusted are excluded from this graph due to small sample sizes *** Annualised JobKeeper payments in Feburary 2021 as a share of ** Pandemic-affected industries include accommodation & food services, FY 2019/20 total revenues arts & recreation services, education, and transport Sources: ABS; RBA Sources: ABS; RBA
FINANCIAL STABILITY REVIEW – APRIL 2021 29 improvement in aggregate economic housing. Residentially secured loans benefit conditions. Vulnerable businesses may find it SMEs by allowing them to borrow larger difficult to continue to operate and/or to meet amounts and at lower interest rates, but they their debt repayments if their revenues do not also increase the probability that business increase sufficiently to cover the withdrawal of insolvencies will result in defaults on loans government support. secured by housing. While this risk of default on There are a couple of factors that are likely to housing debt amplifies the financial stress help moderate the rise in insolvencies following experienced by small business owners and the end of the moratorium period. Support would negatively affect housing markets, it is measures have prevented business insolvencies unlikely to cause significant issues for banks, as not only through cash support, but also by most borrowers hold positive equity in their giving businesses more time to wind down homes, and SME loans account for only operations without entering into insolvency. 15 per cent of total outstanding credit. This suggests that a larger-than-usual share of Moreover, around one-third of businesses that firms ceased trading without becoming were still receiving JobKeeper payments at the insolvent and so creditors incurring losses. beginning of 2021 were sole traders, suggesting Further, changes to the insolvency framework that for these firms at least, the flow-on effects of and the recently announced SME Recovery Loan any business insolvencies for households Scheme are expected to provide better through a reduction in employment are likely to outcomes for some small business owners and be fairly small. their creditors (discussed further in ‘Chapter 4: Domestic Regulatory Developments’). Commercial property risks are greatest Businesses now have more options for debt for retail and also offices restructuring and, in the case of insolvencies, Banks are closely monitoring their commercial new expedited processes will help to reduce property exposures that have been most costs. affected by the pandemic, in particular the office Business insolvencies will have flow-on effects to and retail property markets (see ‘Box B: Risks in households, both by reducing employment and Retail Commercial Property’). Impairment rates because just under 30 per cent of loans to SMEs on commercial property lending remain low, are secured by (most likely the business owners’) consistent with relatively low LVRs and strong debt covenants leading into pandemic, but are expected to rise. While banks’ direct commercial Graph 2.16 property exposures account for only about Business Insolvencies 6 per cent of their total assets in aggregate, Corporates and unincorporated enterprises, seasonally adjusted no no there is considerable variation across banks (for Australian-owned banks, the range is 1,600 1,600 0–16 per cent). Moreover, banks’ effective 1,200 1,200 exposures are higher than their direct exposures because, as noted above, some business lending 800 800 is secured by commercial property. Non-bank
400 400 lenders remain active in the sector and they can influence conditions for banks by competing on 0 0 2015 2016 2017 2018 2019 2020 2021 lending standards, and by financing deals which Sources: AFSA; ASIC; RBA also involve banks.
30 RESERVE BANK OF AUSTRALIA Vacancy rates continued to rise across most CBD logistics and warehousing facilities partly due to office markets in the December quarter 2020, the accelerated shift towards online retailing and in Sydney and Melbourne are currently (Graph 2.19). Unlike in other sectors, sales around their highest levels in about 20 years transactions in the industrial property market (Graph 2.17). About one-quarter of reported did not decline in 2020. For diversified CBD office vacancies in these cities are due to commercial property investors, strong existing tenants seeking to sublet some space, conditions in the industrial property market are which means owners have still been receiving at expected to cushion the impact of declining least some rent. The increase in vacancy rates valuations and rental income in the retail and has been similar across property grades to date, office sectors. Transactions data from but secondary-grade office buildings tend to be 2015–19 suggest that about one-third of large more vulnerable when demand is falling as office and retail property investors had also tenants take advantage of incentives to move to purchased industrial property. higher-quality premises. Tenant demand for offices is expected to remain weak in the early stages of the economic recovery, with some staff at many businesses Graph 2.18 continuing to work at least partly from home. Office Property Prime CBD markets index % Office supply will expand further this year as 2009 = 100 Returns new office buildings are completed, albeit by 200 12 less than last year, and most new office space Valuations* Discount rate** has pre-committed tenants. Measures of office 150 9 10-year AGS rents and valuations have declined only slightly yield*** 100 6 since the pandemic, although the low number Effective rents of sales transactions in 2020 increases the 50 3 uncertainty about recent price trends Spread to AGS 0 0 (Graph 2.18). 1994 2007 2020 2007 2020 * JLL Capital Value Indicator Valuations and rents for industrial property have ** The rate applied to properties’ projected cash flows to estimate their present value continued to grow, reflecting strong demand for *** Australian Government Securities; spread to AGS in percentage points Sources: JLL Research; MSCI; RBA
Graph 2.17 Graph 2.19 Office Vacancy Rates Capital city CBD markets Industrial Property % % index $b Total 2009 = 100 Transactions** Melbourne 20 20 Other CBDs* Sydney 200 6 10 10 Valuations*
150 4 % Sub-lease** %
Face rents 4 4 100 2 2 2
0 0 50 0 1990 1995 2000 2005 2010 2015 2020 2010 2015 2020 2010 2015 2020 * Brisbane, Perth and Adelaide * JLL Capital Value Indicator; prime grade ** Share of total office space offered for sub-lease ** Total value of transactions over $5 million Sources: JLL Research; RBA Sources: JLL Research; RBA
FINANCIAL STABILITY REVIEW – APRIL 2021 31 Box B Risks in Retail Commercial Property
The pandemic has accelerated As demand for retail tenancies declined structural change and so has added through 2020, retail vacancy rates increased to strains for retail commercial sharply (Graph B.2). They are likely to increase property further with some department stores and Retail commercial property in Australia was large retailers announcing plans to further already facing a challenging environment reduce the size of their floor space over the prior to the pandemic. The margins of next couple of years. This will place further retailers, particularly bricks-and-mortar downward pressure on rents and valuations, retailers for discretionary goods, were being which have declined by 6 and 15 per cent compressed by intense competition from since early 2019 respectively. both large international and online The outlook is particularly uncertain for [1] retailers. In addition to this reducing regional and sub-regional shopping centres retailers’ ability to pay high rents, the shift to (those anchored by full-line or discount online retailing was decreasing the demand department stores anywhere in Australia, for retail commercial property premises. including in capital cities and CBDs). These These forces had resulted in falling retail centres rely on maintaining a breadth of commercial property rents and prices tenants to sustain high levels of occupancy. (Graph B.1). The need for social distancing Together these centres account for roughly through the pandemic rapidly accelerated two-thirds of gross lettable area of all the trend towards online retailing in 2020. shopping centres. In contrast, risks around With Australia having a relatively low share of earnings and profitability in ‘neighbourhood online retailing relative to other advanced centres’, are somewhat lower. The anchor economies, it is likely this shift will continue to depress demand for retail properties. Graph B.2 Retail Vacancy Rates* Graph B.1 By shopping centre type** Structural Change in the Retail Sector % % index % Retail property* Online share of retail 2009 = 100 sales (excluding fuel) Neighbourhood CBD 125 30 10 10
Valuations** United Kingdom
100 20 5 5 Face rents Australia 75 10 Sub-regional United Regional States 0 0 1995 2000 2005 2010 2015 2020 50 0 * 2004 2012 2020 2004 2012 2020 Vacancy rates for specialty stores ** Regional centres are anchored by department stores, sub-regional * Regional shopping centres by discount department stores, and neighbourhood by supermarkets; ** JLL Capital Value Indicator CBD includes a variety of retail formats Sources: ABS; JLL Research; ONS; RBA; US Federal Reserve Sources: JLL Research; RBA
32 RESERVE BANK OF AUSTRALIA tenant in these centres are supermarkets, The financial position of larger listed which have fared better during the retail landlords remains sound pandemic. While vacancy rates in CBD Large real estate investment trusts (REITs) shopping centres are very high, they account own around three-quarters of regional and for only around 4 per cent of gross lettable sub-regional shopping centres. Most of these area. large REITs are listed on the Australian Securities Exchange (A-REITs), and there is While there are risks for commercial good information available to assess the property investors the financial financial stability risks from this part of the stability risks seem low sector. A-REITs had total assets equivalent to When vacancy rates increase and rents about 10 per cent of GDP at the end of 2020 decline, indebted landlords need to use a (most of which are CRE assets), or about larger share of their earnings to meet debt 15 times the holdings of unlisted trusts. repayments. Although lower interest rates Nearly all A-REIT securities are held by work to lower debt-servicing burdens, for a institutional investors, with around two-thirds large enough decline in earnings some may held by superannuation funds, and the bulk find it difficult to service their debt. This raises of the reminder held by insurance the potential for asset fire sales, further companies, other investment funds and depressing retail property prices. Large price offshore entities. There are also unlisted REITs falls would see a wider range of leveraged of varying sizes that own retail commercial investors breach loan covenants, requiring a property. Some unlisted REITs are limited to review of their situation with their lenders only wholesale and institutional investors, and possible further property sales. though others are also available to retail investors. Historically in Australia and internationally, losses on commercial real estate (CRE) have Over one-fifth of all A-REITs have sizable accounted for a large share of banks’ losses in exposures to shopping centres. Reflecting downturns.[2] For this reason, lenders and the decline in expected future earnings since financial regulators typically pay close the start of the pandemic, their share prices attention to the exposure of the financial have under-performed relative to other A- sector to CRE. The available information REITs and the broader market (Graph B.3). suggests that financial stability risks from Retail A-REITs entered the pandemic in good retail CRE are currently lower than previous financial health. As a result, they were well- retail sector downturns. This reflects that CRE placed to absorb the sharp temporary lending has experienced only moderate reduction in earnings as rental waivers were growth over recent years and has been granted under a mandatory code of conduct subject to conservative lending practices. established by the National Cabinet (to Moreover, the largest landlords have support tenants experiencing temporary maintained conservative balance sheets, financial stress during COVID-19). Retail A- which will position them well to cope with REITs have relatively low leverage and have the challenges posed by weakening rental been easily able to make debt repayments demand. despite some reduction in their profitability.
FINANCIAL STABILITY REVIEW – APRIL 2021 33 Profitability of retail A-REITs rebounded Both listed and unlisted REITs typically have towards the end of 2020, as tenants resumed low leverage and debt service obligations. paying rent given trading improved, though This reflects internal risk-management it remains low relative to recent years strategies as well as lenders’ underwriting (Graph B.4). There are ongoing risks to parameters in their policies, which are earnings, but a mitigating factor is that retail designed to protect lenders against losses in A-REITs have diversified portfolios with assets the event of sharp falls in income or asset in various locations, and most have assets prices. Over the past year, retail A-REITs have across a range of retail or broader been easily able to cover their interest commercial property segments. Retail A- expenses with current earnings, with the low REITs also have ample liquidity, which they level of interest rates supporting their ability generally increased in early 2020 in response to do so. Leverage has also remained low, to the more uncertain outlook. and declined for most A-REITs in the second half of 2020. For the largest retail A-REITs, the vast majority of debt outstanding has been sourced from Graph B.3 capital markets, both onshore and offshore. A-REITs’ Share Price Indices 4 January 2016 = 100 In addition to issuing senior bonds and index index commercial paper, some retail A-REITs have ASX 200 120 120 issued debt via private placement. Drawn bank debt accounts for just 7 per cent of total 100 100 ASX 200 A-REIT debt outstanding for the 6 largest retail A-
80 80 REITs, although they also currently have much larger undrawn bank loan facilities 60 60 Retail A-REIT* (equivalent to over one-third of total debt
40 40 currently outstanding). Smaller retail A-REITs 2016 2017 2018 2019 2020 2021 * Index constructed from 9 listed A-REITs with substantial shopping rely more heavily on banks for their funding centre ownership; weighted by size Sources: Bloomberg; RBA needs, though in aggregate retail A-REITs’ bank debt outstanding accounts for less than 2 per cent of banks’ overall commercial Graph B.4 property exposures. Retail A-REITs’ Financial Position* % ratio Profitability Liquidity There was good access to debt funding in 16 10.0 Range across A-REITs 2020 for at least large retail REITs. A number 8 1.0
0 0.1 of entities issued equity, raised debt and Aggregate refinanced existing facilities to help them % Leverage Interest coverage ratio 45 24 cover upcoming maturities. The largest A-
30 12 REIT by market capitalisation, SCENTRE,
15 0 issued 60-year subordinated hybrid notes in 0 -12 2020. Accordingly, funding pressures in the 2012 2016 2020 2012 2016 2020 * Profitability measured by return on assets, liquidity by current assets next few years appear well contained. Less over current liabilities (log scale), leverage by debt over assets, and interest coverage by earnings over interest expenses; sample covers 7–10 A-REITs with substantial retail property holdings over period than a quarter of outstanding bonds are due shown Sources: Morningstar; RBA to mature by the middle of the decade.
34 RESERVE BANK OF AUSTRALIA Some smaller retail landlords, with exposures are low as a share of total banking less diversified portfolios, may find it system assets. The 4 major banks account for difficult to manage declines in the bulk of exposures, with a smaller share earnings belonging to foreign-owned banks. Neighbourhood and CBD centres are often Individually, Australian-owned banks’ direct owned by smaller investors, which reduces retail CRE exposures are also low, ranging the information available on their financial between 0 and 3½ per cent of their total resilience. The wider ownership base for assets. Further, banks’ lending standards for these types of centres reflects that they are commercial property have improved typically smaller and therefore require less considerably in recent years. According to the capital to purchase or develop. Some are Australian Prudential Regulation Authority’s owned by REITs, but many others are owned (APRA’s) 2018 review on commercial property by private companies, self-managed lending, the vast majority of CRE loans have superannuation funds or high net worth been written with loan-to-valuation ratios individuals. Because of this diversified (LVRs) well below 65 per cent and with ownership by private entities there is little earnings equal to 1.5 times interest [3] information on the financial health of these expenses. The application of loan smaller landlords. However, given their small covenants – such as minimum ICRs and low size most leverage presumably comes from LVRs – has become more nuanced over the banks and, to a far lesser extent, non-bank past decade, and provide an early signal for lenders, and so will conform to those lenders’ landlords and their lenders if the capacity to risk controls. repay debt looks to be deteriorating. Smaller landlords’ greater exposure to Banks also have indirect links to retail neighbourhood centres, which have fared property though business loans that use better during the pandemic, implies smaller, standalone retail property as an somewhat less risk of a loss in earnings. underlying security. These are not included in However, some smaller landlords may still be data on banks’ exposure to CRE and the vulnerable to significant declines in earnings overall size of these bank exposures is not if their underlying balance sheet position is known. While secured business lending weak, if the quality of their assets is poor, or if their portfolio has little asset diversification. Graph B.5 Banks’ Retail Property Exposures* Overall, risks to lenders from losses % Year-ended growth % on retail property exposures 25 25 appear low 0 0 While some indebted landlords will find it % Share of total banking system assets % difficult to meet their debt repayments, the 1.6 1.6 near-term risks to financial stability from retail 0.8 0.8 property appear to be low overall. Growth in 0.0 0.0 banks’ lending for retail commercial property 2004 2008 2012 2016 2020 has been moderate in recent years Major banks Other Australian Foreign * Excludes overseas exposures (Graph B.5). Retail commercial property Sources: APRA; RBA
FINANCIAL STABILITY REVIEW – APRIL 2021 35 accounts for a quarter of total credit, the perhaps even losses to lenders. However, the share of these loans secured by retail overall risk to banks seems low, given that property (rather than other assets) will be collateralised loans typically incorporate a much smaller. There is a risk that business healthy positive equity buffer and that these insolvencies could lead to distressed are highly diversified across regions and property sales of these assets, potentially owners. leading to price declines in some areas and
Endnotes [1] Carter M (2019), ‘Competition and Profit Margins [3] APRA (Australian Prudential Regulation Authority) in the Retail Trade Sector’, RBA Bulletin, June, (2018), ‘Strictly Business: An Update on viewed 1 April 2021. Commercial Real Estate Lending’, APRA Insight, [2] Ellis L and C Naughtin (2010), ‘Commercial Issue 4. Available at
36 RESERVE BANK OF AUSTRALIA 3. The Australian Financial System
The Australian financial system has remained There are a number of other longer-term resilient through a tumultuous year for the challenges for financial institutions to manage. economy and financial markets. The risks posed by information technology (IT) After a substantial decline in the first half of malfunctions and malicious cyber attacks are 2020, banks’ profitability recovered in the growing and a significant event could threaten second half and analysts expect it to strengthen financial stability. Another challenge will be to further in 2021. This has helped raise banks’ manage the broad range of risks arising from capital positions from already strong levels. climate change. These do not currently pose a Banks have abundant liquidity and funding. substantial risk to financial stability, but they Measures of banks’ asset quality have could over time if climate change risks to deteriorated a little in recent months as loan Australian financial institutions grow and are left repayment deferrals have come to an end and unaddressed. And financial institutions need to support for households and businesses has continue to maintain a focus on governance and tapered. However, banks had increased their embed a healthy culture to address the provision balances to absorb the impact of misconduct that has become apparent over the future defaults. past few years. Available information also points to other Banks resilience is supported by their financial institutions being resilient. The financial profitability … impacts of the pandemic tested the liquidity management of superannuation funds, but their Profitability recovered over the second half of systems proved effective in navigating this 2020 as banks raised provisions for credit challenge (see ‘Box C: What did 2020 Reveal impairments at a slower pace than in the initial about Liquidity Challenges Facing stages of the pandemic (Graph 3.1). Bad debts Superannuation Funds?’). General insurers will rise over 2021 as fiscal support is reduced remain well capitalised and have increased their and a small share of loans previously granted provisions for potential business interruption repayment deferrals move into arrears (see claims arising from the pandemic. However, the below). However, banks have bolstered their life insurance industry has to address stock of provisions in anticipation of these longstanding issues that continue to result in losses. Current provisions are around 40 per cent losses. Financial market infrastructures have above recent years, though still below the levels recently experienced some operational in the aftermath of the global financial crisis. Net disruptions, underscoring the importance of interest income was broadly unchanged over continually assessing and improving their 2020, while costs increased a little relative to resilience. income. Analysts expect banks’ headline return
FINANCIAL STABILITY REVIEW – APRIL 2021 37 on equity (ROE) to continue to recover over the to-earnings ratios have risen since the middle of coming year, and be above their cost of equity. last year and the implied cost of capital has As interest rates have fallen a larger share of declined relative to other listed companies bank deposits has paid low interest rates (Graph 3.2). More generally, estimates of the (between zero and 25 basis points). This can equity risk premium for listed companies (the squeeze net interest margins (NIMs) because as implied cost of equity minus the risk-free interest rates fall, deposits that already receive zero or rate) indicate that increased risk-taking by very low interest rates have not been repriced investors has not unduly bid up the prices of lower in line with lending rates or the return on equities over 2020, since the equity risk liquid assets. premium is marginally above its average of recent years. Despite this, the evidence for Australia is that lower rates do not have a meaningful impact on … and strong capital ratios overall bank profitability. Lower rates are generally associated with a small reduction in Australian banks’ profitability over recent years banks’ NIMs, but this effect is offset by a has enabled them to build substantial capital reduction in borrowers’ debt-servicing burdens buffers to absorb future losses. Their Common (lowering bad and doubtful debts) and an Equity Tier 1 (CET1) capital ratios are increase in aggregate demand. NIMs are also substantially above their prudential minimum being supported in the current environment by requirements, giving them large management the broad reduction in banks’ funding costs. capital buffers in addition to 2½–3½ percentage Funding costs are estimated to have fallen by a points of regulatory capital buffers (Graph 3.3). little more than the cash rate since the start of Reflecting this, the 4 major banks’ capital ratios 2020 because of a shift in the composition of on an internationally comparable basis are deposits (towards cheaper at-call deposits) and estimated to be towards the top of the range of the Reserve Bank’s package of policy measures similarly sized banks globally and at a level that (including availability of cheap funding provided has historically been sufficient to withstand [2] by the Term Funding Facility (TFF)).[1] almost all previous banking crises. Mid-sized and smaller banks are also well capitalised. Financial market indicators also suggest Additional capital over regulatory minima for investors are confident that banks’ future earnings will remain resilient. Banks’ share price-
Graph 3.1 Graph 3.2 Bank Valuations Banks’ Profitability ratio Forward price-to-earnings ratio ratio % Return on equity* % 20 20 Pre-provisions 16 16 15 15
8 8 10 10 ASX 200 banks
% Equity risk premiums* % % Provisions as a share of loans % 10 10 1.0 1.0 7 7
0.5 0.5 4 4 ASX 200 (excl. banks) 1 1 0.0 0.0 2005 2009 2013 2017 2021 2005 2009 2013 2017 2021 * Forward earnings yield spread to 10-year real Australian Government * Dot represents forecast based on 12-month forward earnings Bond Sources: APRA; RBA; Refinitiv Sources: RBA; Refinitiv
38 RESERVE BANK OF AUSTRALIA these banks are generally similar to, or larger Liquidity in the banking system is than, those of the major banks. also high Banks have also been able to increase their Banks’ holdings of high-quality liquid assets capital ratios since the onset of the pandemic. (HQLA) have increased over the past year, CET1 capital ratios for the banking system as a facilitated by ample access to low-cost funding whole rose by over 100 basis points over this (in part due to RBA bond purchases) and low time, with around $16.9 billion in additional demand for credit. This, in combination with the CET1 capital being generated. More than half of undrawn portion of the TFF (which is treated as this came from retained earnings, reflecting a liquid asset), has caused banks’ liquidity continued profitability and reduced dividend coverage ratios (LCRs) to rise substantially payout ratios (in line with guidance from the compared with late 2019 (Graph 3.4). The Australian Prudential Regulation Authority increase has been even more pronounced for (APRA)). The remainder mostly reflected NAB’s smaller banks than for the 4 major banks. LCRs $4.25 billion in new issuance in the June quarter are currently above banks’ targeted levels but last year and new issuance associated with could shift back to within targets over the next dividend reinvestment. Looking ahead, planned 12 months. Banks’ LCRs could reduce when the asset sales are expected to provide further window of taking up remaining TFF allowances support to banks’ capital positions. expires on 30 June 2021. The size of this reduction will depend on the extent to which In recognition of banks’ healthy capital positions, banks draw down on remaining allowances as and the improved economic outlook, from well as how TFF funds are invested. Many banks December 2020 APRA relaxed its guidance on have indicated in liaison that they plan to take banks’ dividends. However, banks will need to up most or all of their remaining allowances retain sufficient capital to ensure they have the ahead of the deadline. capacity to continue to provide credit to the real economy and in doing so support the economic APRA recently approved requests from banks for recovery from the COVID-19 recession. a reduction in their allocations under the Reserve Bank Committed Liquidity Facility (CLF), reducing the total CLF available by $84 billion to $139 billion. The CLF is intended to be large
Graph 3.3 CET1 Capital Ratios Graph 3.4 Using current capital framework, December 2020 % % Liquidity Coverage Ratio All currencies % %
15 15 180 180
Range across all banks* 160 160 10 10
140 140
5 5 120 120 Major banks**
0 0 100 100 Major banks Other ASX-listed Unlisted banks** banks Minimum requirement Regulatory buffer* 80 80 2015 2016 2017 2018 2019 2020 Additional capital * * Excludes confidential Pillar II requirements From the 10th to 90th percentile of all banks’ liquidity coverage ratios ** Some banks have capital ratios above 20 per cent (not shown) ** Weighted average of the major banks’ ratios Sources: APRA; RBA Sources: APRA; RBA
FINANCIAL STABILITY REVIEW – APRIL 2021 39 enough to offset the limited amount of HQLA expiration and managing the timing mismatch available in Australia due to low levels of govern- through holding excess liquid assets. Liaison ment debt. Over the past year, issuance of with banks indicates that they are carefully Australian Government Securities and semi- planning for this task and will choose based on government bonds has increased significantly to the relative cost and efficiency of these options fund the fiscal policy response to the pandemic. closer to the time. In doing so, banks are also In its announcement APRA noted that if the mindful of the potential impact of expiring TFF amount of government securities outstanding funds on their Net Stable Funding Ratios, which continues to increase beyond 2021, the CLF may could fall by up to 4 percentage points (from a no longer be required in the foreseeable future. current level that is 24 percentage points above Banks have ample access to low-cost deposit their minimum requirement). and other funding, and have reduced their funding from wholesale debt. Spreads on short- Banks’ non-performing loans have risen term and long-term wholesale debt have fallen Measures of banks’ asset quality have to historically low levels, given reduced supply deteriorated somewhat in recent months and market conditions. Strong demand for (Graph 3.6). This trend is likely to continue over Australian banks’ debt is highlighted by spreads coming months given the unwinding of support declining for Tier 2 debt, even though the major measures such as JobKeeper (see ‘Chapter 2: banks need to raise more of this debt to satisfy Household and Business Finances in Australia’). APRA requirements for Total Loss Absorbing The end of APRA’s concessional treatment for Capacity. loan repayment deferrals in March will also lift loan arrears, as APRA’s concession allowed most Banks will need to manage future loans on deferral as part of a COVID-19 support refinancing requirements package to be treated as ‘performing’. The The TFF has lowered banks’ funding costs and quality of Australian banks’ New Zealand assets provided them with ample liquidity. However, has also declined. banks will face a sizeable refinancing task when Current indications are that the increase in non- these funds must be repaid in 2023/24 . Banks performing loans will be modest. The vast have drawn $81 billion that is due for repayment majority of borrowers that requested loan by around September 2023, and could draw an repayment deferrals in 2020 have subsequently additional $109 billion by June 2021 (of which $16 billion has already been drawn) that would Graph 3.5 be due for repayment after 3 years. Together Banks’ Refinancing Task with bonds maturing, banks will need to Semi-annual $b $b refinance around $120 billion in the 6 months Bond maturities TFF repayment (2023) TFF repayment (2024)* around each of these dates (Graph 3.5). This will 120 120 be banks’ largest ever refinancing task, though there are many factors that will influence how 90 90 challenging it proves to be (including demand 60 60 for loans over coming years). Banks have a number of options to manage 30 30 these repayments. These include raising debt in 0 0 wholesale markets at the time, spreading out 2012 2016 2020 2024 * Assuming banks draw all remaining allowances by June 2021 the refinancing task before and/or after the TFF Sources: Bloomberg; RBA
40 RESERVE BANK OF AUSTRALIA been able to resume repayments, and banks Statement on Monetary Policy over the past year. entered 2021 with a very low share of non- APRA’s modelling showed that the aggregate performing loans. Most loans, including those in CET1 capital ratio across all banks would decline arrears, are well secured and the resilience of materially under this scenario to 6.6 per cent but property prices to date – particularly for remain well above the prudential minimum of residential property – should further limit 4.5 per cent. The main driver of the declines is potential losses for lenders (and enable credit losses, of which losses on business credit borrowers struggling with repayments to sell contribute a bit less than half, while losses on without losing much of their previously residential mortgages contribute around one- accumulated equity). The government’s third. Rising risk weights account for most of the announcement of the SME Recovery Loan remaining declines in capital ratios. Consistent Scheme will also support credit quality by with this, the RBA’s reverse stress testing model offering cheap loan refinancing to firms that implies that it would take a recession have been heavily affected by the pandemic but comparable to the Great Depression for are otherwise healthy.[3] Banks have also raised CET1 capital ratios to fall below 6 per cent.[5] substantial provisions in anticipation of Nonetheless, both APRA’s and RBA’s results are expected credit losses (as noted above) and they subject to considerable uncertainty and it is have scope to raise further provisions (while possible that greater stress could arise from remaining profitable) if the need arises. factors that are not well captured by the Even if economic conditions were to deteriorate modelling. significantly, stress tests suggest that banks would remain sound. APRA recently assessed APRA is refining the regulatory whether banks could withstand a severe framework for banks … economic contraction, in which GDP fell by In December, APRA released an update of its 15 per cent, unemployment rose to over proposed revisions to the capital framework.[6] 13 per cent and national housing prices fell by These revisions will not require the banking over 30 per cent.[4] This is much worse than any system to raise additional capital, but will of the downside scenarios presented in the increase the flexibility of bank capital and improve the allocation of capital to risk. The reforms also embed the ‘unquestionably strong’ Graph 3.6 benchmark within the capital framework and Banks’ Non-performing Loans* Domestic books, share of loans by type more closely align the measurement of capital % % Total Housing Business ratios with recently revised Basel III standards.
4.5 4.5 One of the aims of the proposed revisions is to Impaired build greater flexibility into the capital
3.0 3.0 framework, so as to increase the ability of banks Non-performing** to use capital and continue to lend during
1.5 1.5 periods of stress. This is addressed by banks having larger capital conservation buffers and Past-due 0.0 0.0 raising the default level of the countercyclical 2011 2021 2011 2021 2011 2021 * Break at June 2019 due to the introduction of the Economic and capital buffer to 100 basis points (from zero). The Financial Statistics; banks have generally been allowed to classify most loans under deferral as part of a COVID-19 support package as performing non-zero countercyclical capital buffer will ** Sum of ‘past-due’ (i.e. 90+ days in arrears and well-secured) and impaired (i.e. in arrears or otherwise doubtful and not well-secured) provide APRA with greater capacity to reduce loans Sources: APRA; RBA
FINANCIAL STABILITY REVIEW – APRIL 2021 41 capital requirements in response to changes in Risks in non-bank financial institutions systemic risks. remain contained … The reforms will also make the capital framework General insurers’ profitability declined to almost more risk sensitive, which will reinforce the zero in 2020 (Graph 3.7). However, they remain incentive for sound lending practices. In well capitalised and analysts expect their particular, higher-risk types of housing loans profitability to recover in 2021. Analysts’ such as investor, interest-only, and highly forecasts for a recovery in profits in 2021 are leveraged loans will require banks to hold more underpinned by expectations that there will not capital than equivalent owner-occupier principal be a repeat of the factors that reduced profits in & interest loans. The average risk weight on 2020. In particular, profits were curtailed by residential mortgages will also increase for the substantial provisioning for potential business banking system as a whole, while there will be interruption (BI) claims arising from the an offsetting decline in risk weights on business pandemic. Recent floods have lifted claims, but lending. APRA expects to finalise the framework analysts currently expect the impact of natural in 2021 and implement it from January 2023. disaster claims to be less than last year (in part because of increased reinsurance cover … and oversaw an orderly bank exit following last year’s catastrophic bushfires and severe storms). However, there is considerable Xinja, a small ‘neobank’ that received its full uncertainty around these expectations. Sharp banking license in September 2019, announced falls in asset prices in early 2020 also resulted in in December 2020 that it would hand back its large investment losses that were only partially banking licence and return all deposits to reversed as asset prices recovered. customers. This decision was made in light of Xinja’s inability to secure enough capital to offset The $1.7 billion of provisions the major general its depletion of cash (resulting from paying more insurers have raised for potential BI insurance for deposits and operating expenses than it payouts mostly came in response to a court received on its assets, which did not yet include ruling that many such policies did not effectively loans). APRA had been working with Xinja for exclude cover for pandemics, despite that being some time prior to ensure that if an exit was the insurers’ intent. The size of insurers’ required, it would be orderly. In the event, APRA’s contingency planning arrangements Graph 3.7 worked broadly as anticipated and in the space General Insurers’ Profitability and Capital of just a few weeks more than 99 per cent of Calendar year % Return on equity % Forecasts* deposits were returned directly to customers 20 20 (with the remainder returned via new accounts 10 10
at NAB). In light of this experience, and what it % Claims ratio** % learnt from other new Australian banks that 75 75 received their licence in recent years, APRA is 65 65 strengthening its requirements for granting new ratio Prescribed capital amount coverage ratio*** ratio 2.0 2.0 banking licences. The revised expectations place General 1.5 1.5 LMI a greater focus on the longer-term sustainability 1.0 1.0 of business models.[7] 2006 2010 2014 2018 2022 * Analyst ROE forecasts from Bloomberg ** Ratio of net incurred claims to net premium; change in reporting basis after June 2010 *** Eligible capital as a multiple of prescribed capital amount or minimum capital requirement (prior to March 2013) Sources: APRA; Bloomberg; RBA
42 RESERVE BANK OF AUSTRALIA exposures to BI claims remains uncertain, in part at non-bank lenders has remained sound, both due to the continuation of legal proceedings on for lending to households and to businesses. this matter (which are discussed further in One indication of the resilience of the sector has ‘Chapter 4: Domestic Regulatory Develop- been its ability to manage loan repayment ments’). APRA has closely monitored the deferrals. Both the share of (prime) customers on potential impact BI could have on insurers and deferral at non-banks and the credit quality of will continue to do so into 2021. their deferred loans (during and after the The low interest rate environment also presents deferral period) appears to be similar to those of some risk to general insurers if they do not banks. reprice policies in response to expected lower investment returns. In addition, insurance … though life insurers have significant policies that cover risks for many years after the problems to address … policy expires (‘long-tailed’) face some risk since The pandemic has had a limited impact on life falling real interest rates increase the discounted insurers’ profits, other than by depressing returns value of insurers’ future liabilities. While most on investment income. However, longstanding general insurance in Australia is short-tail (that is, issues continue to result in them making losses policies where claims are identified and made (Graph 3.9). Individual disability income within about a year), compulsory third party insurance has been a major contributor to these motor vehicle, product and public liability, losses, reflecting a long period of substantial professional indemnity and workers underpricing and overly generous product compensation insurance are all long-tail classes features and terms that have resulted in higher- that are exposed to this risk. However, general than-expected claims. APRA intervened in late insurers in Australia mostly mitigate this risk 2019, requiring firms to adjust their insurance through asset-liability maturity matching. policies to make them more sustainable and Lenders’ mortgage insurers (LMIs) profitability imposing capital charges until these measures has been affected by the COVID-19-induced were implemented. While this intervention was economic downturn, but they retain a very temporarily suspended in March 2020 owing to strong capital position. The decline in profits in COVID-19, APRA reinstated it in October 2020. 2020 resulted from pandemic-related increases The adequacy of firms’ responses are currently in the expected future value of mortgage being assessed by APRA. However, this issue is insurance payouts and an associated increase in their reserves. However, the resilience of the economy, and particularly housing prices, has Graph 3.8 materially improved the outlook for LMI profits, Non-bank RMBS $b Issuance $b as has increased demand from first home 7.5 7.5 buyers. 5.0 5.0 Non-banks have grown their housing lending 2.5 2.5 since late last year, after curtailing it at the height bps Primary market pricing* bps of the pandemic. As funding conditions have 300 300 Prime Non-prime improved, issuance of residential mortgage- 200 200 backed securities (RMBS) by non-bank lenders 100 100 has risen to high levels and spreads have 0 0 2005 2009 2013 2017 2021 declined to their lowest levels since 2007 * Face-value weighted monthly average of the primary market spread to bank bill swap rate for AAA rated notes (Graph 3.8). Liaison indicates that credit quality Sources: Bloomberg; RBA
FINANCIAL STABILITY REVIEW – APRIL 2021 43 expected to persist for some time given the between 18 and 23 November. An unrelated long-term nature of these insurance contracts issue also caused a delay of several hours in the and the associated large book of legacy settlement of equity trades on 17 November. business, as well as the potential for increased The Australian Securities and Investments mental health issues arising from the pandemic. Commission (ASIC) has commenced an investigation into whether ASX met its … and financial market infrastructures obligations under its Australian Market Licence, (FMIs) continue to focus on improving including whether it has sufficient financial, operational resilience technological and human resources to operate The operational resilience of FMIs, such as its markets. The Bank and ASIC have expressed central counterparties (CCPs), securities significant concern regarding these incidents settlement facilities and high-value payment and have asked ASX to have an independent systems, is important to enable financial system review of the incidents conducted in the first participants to prevent credit or liquidity risks half of 2021. building up. More broadly, this can help to While other FMIs in Australia have not underpin confidence in the operation of capital experienced similar operational issues in recent markets. Recent events have shown the months, they continue to pursue improvements. importance of FMIs continually assessing and For example, the Bank is in the final stages of a improving their operational resilience. multi-year project to refresh the core infras- In late 2020, ASX experienced a number of tructure for its high-value payment system, the significant operational incidents that affected Reserve Bank Information and Transfer System the availability of systems used in trading and (RITS). It is also implementing a program of settlement of ASX equities and equity options. improvements to its IT operational practices that Problems following a major upgrade to ASX’s include a number of initiatives aimed at core equity trading platform, ASX Trade, resulted enhancing the operational stability of RITS. in the closure of the ASX market for most of the Another requirement for financial participants to day on 16 November, while ASX’s Centre Point be able to manage risk appropriately is for FMIs order matching service was partially unavailable to be operating when needed. In recognition of this, the London-based CCP LCH Limited (LCH Ltd), which provides clearing services to Graph 3.9 Australian participants in the over-the-counter Contributions to Life Insurers’ Profitability Calendar year interest rate derivatives market via its SwapClear % % service, has been working to better align its 15 15 operating hours with the Asia-Pacific markets
10 10 that it serves. Due to time zone differences, these services are typically unavailable for 5 5 several hours at the start of the Australian 0 0 business day and LCH Ltd’s participants bear
-5 -5 bilateral credit risk exposures to one another until the CCP is able to clear the trades that have -10 -10 2010 2012 2014 2016 2018 2020 been executed. LCH Ltd has brought forward its Individual death/TPD* Non-participating investment-linked Individual disability Other** opening time incrementally in recent years. The Group policies Return on equity
* TPD = total and permanent disability Bank’s 2020 Assessment of LCH Ltd’s SwapClear ** Includes profit from other non-risk business Sources: APRA; RBA Service sets a regulatory priority for LCH to
44 RESERVE BANK OF AUSTRALIA continue this work, while maintaining the manage risk. The integrity of data is particularly resilience of its operations. important since it dictates the ability of banks to disburse funds or collect on monies due and, in Financial institutions need to carefully the extreme, if violated it could raise questions manage technology risks … about the institution’s solvency. More generally, Risks to financial institutions’ IT systems – from any data breaches that cause consumers and both malicious attacks and malfunction – creditors to lose confidence in the security of require ongoing attention and robust the financial system could see banks face management, both globally (see ‘Chapter 1: The liquidity challenges. Global Financial Environment’) and domestically. These risks have grown as digital platforms and … and address the longer-term service channels become more ingrained and challenges of climate change more complex and as a result of the increased Climate change presents an ongoing challenge incidence of remote working arrangements. for the financial system, by exposing it to risks They have recently been highlighted by a data that will rise over time and, if not addressed, breach involving a legacy file sharing service run could become considerable.[8] These financial by Accellion, a third-party technology provider, risks are already beginning to become apparent which affected a wide range of entities including in some cases. For example, investors in BP and ASIC and the Reserve Bank of New Zealand. The Shell suffered losses as both heavily wrote down operational disruptions experienced by ASX in the value of their oil and gas assets in June 2020. November (discussed above) also demonstrate This was partly in response to the drop in energy the risks associated with technology prices associated with the pandemic and global malfunction. The constantly evolving nature of recession but also in expectation that the global cyber risks means it is critical that financial economic recovery will be associated with an institutions regularly update and upgrade their accelerated pace of transition to a lower carbon defences. In recognition of this, Australian economy. regulators have a number of initiatives to One way in which financial institutions are support financial institutions’ efforts to exposed to the physical risks of climate change strengthen cyber resilience (see ‘Chapter 4: is via the potentially negative impact it could Domestic Regulatory Developments’). have on the value of housing collateral in Cyber attacks and incidents are most likely to locations that are more affected by climate risk, involve manageable financial losses for specific particularly if these risks become uninsurable. institutions, but they could have systemic Such regions include agricultural and farming implications in certain circumstances. To be regions in NSW and Queensland, as well as systemic, the impact of cyber attacks and metropolitan areas adjacent to the ocean and incidents would have to affect multiple waterways. Data show that the share of banks’ institutions, either directly or indirectly. This current mortgage exposures that are in regions could occur if they affect third-party providers or projected to experience a material increase in software used widely across the financial system. climate damage is around 6 per cent.[9] Insurers Similarly, if such an incident affected critical are more exposed to physical risks from climate nodes, such as an FMI (including payment change through policies covering natural systems or CCPs) for a prolonged period it could disaster damage to property, motor vehicles, directly impact the ability of firms and crops and other assets. Banks also face risk from households to engage in economic activity and any policy and technological changes intended
FINANCIAL STABILITY REVIEW – APRIL 2021 45 to minimise climate change (‘transition risk’). Culture and governance also need This is most likely to affect the quality of bank ongoing focus lending to carbon-intensive industries, which Financial institutions also need to continue to account for around 20 per cent of banks’ total focus on culture and governance issues that exposures. Banks and insurers need to measure became apparent in recent years. If not and address these risks early to mitigate the addressed, cultural problems can significantly future financial risk they pose to the institution, erode public trust in financial institutions. They and so also to future financial stability. can also reduce profitability through the Some work is starting to be done by industry to payment of hefty remediation costs and measure and address the financial risks of penalties (such as those paid by CBA and climate change. For example, the Climate Westpac for significant breaches of anti-money Measurement Standards Initiative – an industry- laundering and counter-terrorism financing led, collaborative framework that sets standards laws) or the imposition of tighter restrictions on for more comprehensive and harmonised their operations (including increased capital disclosure of data on risks posed by climate charges, such as those imposed on the 4 major change – was launched last year. Around half of banks, Macquarie Bank and Allianz). Recent ASX100 listed financial firms are also disclosing failures to correctly measure various banks’ LCRs climate risks following the global framework also show the risks associated with not established by the industry-led Task Force on prioritising the measurement of financial risk. Climate-related Financial Disclosures. In recognition of the importance of these issues, Meanwhile, APRA will release a draft of its cross- APRA recently restarted work on ensuring that industry prudential practice guide on the remuneration arrangements encourage good management of climate-related financial risks for practice and culture. It also completed a review consultation later this month, with a view to of ANZ, CBA and NAB’s implementation of the finalising in the second half of this year. It is also Banking Executive Accountability Regime undertaking work on measuring the risks that (BEAR). (Westpac was not included due to climate change could pose to banks by ongoing investigations, now complete, into conducting a ‘climate vulnerability assessment’ potential breaches of the Banking Act.) APRA in 2021, working together with banks and the found that while each of these 3 major banks Council of Financial Regulators. The work had designed adequate frameworks to domestically is in line with the increasing focus implement BEAR, they all have further work to globally by regulators on addressing climate achieve acceptably clear and transparent risks in the financial sector. accountability.
Endnotes [1] See Garner M and A Suthakar (2021), ‘Developments [3] Details of the scheme can be found at the Treasury in Banks’ Funding Costs and Lending Rates’, RBA website. Available at
46 RESERVE BANK OF AUSTRALIA [6] See APRA (2020) ‘A More Flexible and Resilient Capital [8] See RBA (2019), ‘Box C: Financial Stability Risks From Framework for ADIs’, Discussion Paper, December. Climate Change’, Financial Stability Review, October. Available at
FINANCIAL STABILITY REVIEW – APRIL 2021 47 Box C What Did 2020 Reveal About Liquidity Challenges Facing Superannuation Funds?
The management of liquidity is essential for 2. funds’ increased need for liquid assets to the superannuation industry. If liquidity is not meet margin calls on hedges (held to managed well, superannuation funds may reduce foreign currency risks); and have to sell assets quickly, potentially for a 3. a temporary relaxation of the system’s value less than expected or, in extreme preservation rules, the Early Release situations, refuse to honour member Scheme (ERS), which enabled members obligations, including requests for portfolio to withdraw up to $20,000 from their [1] changes. The substantial size of the superannuation balance if they had been superannuation industry in Australia means adversely impacted by the pandemic.[2] that poor liquidity management could In response, super funds substantially potentially have a systemic impact. Super increased their liquidity: aggregate cash funds regulated by the Australian Prudential balances increased by $51 billion over just Regulation Authority (APRA) manage the March quarter 2020. A portion of this was $2.0 trillion in assets or around 100 per cent subsequently unwound as funds made ERS of annual GDP. If super funds needed to sell payments. This accumulation of cash assets on a large scale, it could amplify asset occurred in an environment of heightened price declines during periods of stress. This demand for liquidity across the financial could also have flow-on effects to the system and reduced depth in various banking sector or particular banks as super markets. To fund the move into cash, super funds (including self-managed funds) own funds were sellers of bonds, foreign equities one-quarter of Australian banks’ short-term and equity units in investment funds debt and equities and account for almost (Graph C.1). While these events showed that 10 per cent of banks’ deposits. If funds (or funds were able to manage liquidity well in their members) were to experience liquidity fairly extreme circumstances, some aspects of strains this could create deposit outflows at their liquidity management plans could be banks that manage super funds’ investment updated. (as opposed to transactional) savings accounts. Member switching into cash was During 2020, the superannuation industry sizable in March 2020 faced significant liquidity management Around half of the increase in super funds’ challenges due to 3 factors that arose cash holdings over the March quarter simultaneously: 2020 was due to members choosing to 1. increased propensity of members to switch from higher-risk investments into switch out of more risky (and so generally cash. While this was equivalent to only less liquid) investment options;
48 RESERVE BANK OF AUSTRALIA around 1½ per cent of funds under balances (Graph C.3). Most of the switching management (FUM) for the system as a into cash came from diversified investment whole, it was substantially larger for some options, particularly balanced and growth super funds. Data collected from 30 funds options due to their high weightings to show that these flows were as high as shares and other growth assets. By contrast, 3–4 per cent of FUM for several large funds switches out of default MySuper products and 8 per cent for one medium-sized fund were small. (Graph C.2). The size of these flows were Super funds retained substantial liquidity larger than previous market dislocations − positions in their diversified investment [3] including the global financial crisis. options despite the magnitude of switching. Switching into cash was driven by a small Funds sold their highly liquid assets (equities pool of active members who switched large and fixed income securities; see Graph C.1) to amounts. These members were generally meet switching requests. However, even after closer to retirement with larger average this, the majority of funds still had at least 40 per cent of their portfolio allocated to very liquid assets and a further one-third to Graph C.1 moderately liquid assets (those that can be Superannuation Funds’ Financial Flows Change in share of total assets, over March quarter 2020* sold within 3 to 30 days). ppt ppt
1.5 1.5 Funds also needed cash to cover 1.0 1.0 large derivative margin calls … 0.5 0.5 Funds also required cash to cover margin
0.0 0.0 calls against currency (and other) derivatives. Super funds use currency derivatives to -0.5 -0.5 hedge foreign exchange (FX) rate risk on their -1.0 -1.0 Cash Bonds Domestic Offshore Domestic investments that are denominated in foreign equities equities investment funds** currencies. Australian-regulated super funds * Excludes valuation changes; direct holdings only ** Shares and other equity issued by non-money market financial investment funds plus net equity of pension funds in life office reserves Sources: ABS; RBA Graph C.3 Switching by Fund Characteristics Graph C.2 Switches into cash, March quarter 2020, share of FUM* % % Member Switching into Cash By age** By average fund balance March quarter 2020, share of FUM* ppt ppt Large funds** Small and medium funds 2.0 2.0
6 6 1.5 1.5
1.0 1.0 3 3
0.5 0.5
0 0 0.0 0.0 Youngest Oldest Lowest Highest funds funds balances balances -3 -3 * Funds under management (FUM) as at December 2019 Individual funds Individual funds ** Reflects quartiles of average member age for each fund; average age * Funds under management (FUM) as at December 2019 is estimated based on the share of members’ benefits in various age ** Funds with FUM greater than $25 billion buckets Sources: APRA; RBA Sources: APRA; RBA
FINANCIAL STABILITY REVIEW – APRIL 2021 49 invest around 35 per cent of members’ funds tended to sell larger shares of foreign equities offshore and survey data indicate that around than other funds. This illustrates that, in most 40 per cent of these offshore investments are circumstances, the liquidity risk involved with hedged.[4] When the Australian dollar foreign currency hedging is at least partly depreciates, the value of these derivatives mitigated by the depreciation of the declines, requiring super funds to make Australian dollar also lifting the Australian payments to their counterparties to mitigate dollar value of underlying foreign assets. This, the risks arising from these mark-to-market in turn, supports funds’ ability to sell some of losses. these foreign assets and close part of their During the first half of March 2020, the hedging contracts. Overall this indicates that Australian dollar depreciated by 15 per cent. super funds’ hedging strategies are robust. As a result, super funds had to pay in excess of $17 billion of margin to their … and the early release scheme counterparties (Graph C.4). Around half of added to liquidity challenges these payments flowed to the 4 Australian Superannuation ‘preservation rules’ require major banks, which, in contrast to super that member benefits are retained within the funds, have net US dollar liabilities. The superannuation system until members reach remainder was primarily paid to foreign retirement age, unless there are investment banks. These margin flows were compassionate grounds or instances of mostly associated with funds’ FX forward severe financial hardship. Recognising the contracts. Some of this margin was returned worsening economic environment, the to – and likely retained as cash by – super Australian Government temporarily changed funds as the Australian dollar recovered in the eligibility criteria for early release of late March. superannuation in April 2020 under the ERS. It appears that funds partly managed this This resulted in $36 billion of ERS requirement by selling some of their withdrawals, equivalent to 2 per cent of FUM underlying foreign currency assets. Fund- as at December 2019. Around half of that level data show that funds with larger occurred during the June quarter. hedging ratios going into the pandemic A number of large funds paid out more than 5 per cent of FUM under the ERS (Graph C.5). As expected, funds most exposed to early Graph C.4 release flows were those with a greater Superannuation Funds’ Hedging Obligations Cumulative change, March 2020 proportion of members that were young and $b US$ Net margin received (LHS) worked in industries most affected by the US$ per A$ (RHS) 0 0.70 pandemic.
-5 0.65 At the time of the initial announcement of the ERS, funds with younger members and -10 0.60 those in pandemic-affected industries cautioned that they could lose as much as -15 0.55 one-fifth of their FUM or more within a -20 0.50 1 Mar 16 Mar 31 Mar matter of months. However, household Sources: APRA; RBA incomes and employment fell by less than
50 RESERVE BANK OF AUSTRALIA anticipated and so withdrawals were smaller superannuation balances, while early than expected. In addition, they were fairly withdrawals were driven by younger evenly spread over time, which helped funds members more exposed to the economic to manage the additional demand for and financial impacts of the pandemic. This liquidity. The improved functioning of meant the liquidity risks were spread across markets after the market turbulence in March members rather than being concentrated. and early April also enabled funds to more Given this, and differences in the easily sell fixed income securities and membership base of super funds, very few equities. Funds also moved quickly to funds experienced both sizable member prepare for the ERS, by selling equities ahead switching and ERS outflows. of the commencement of the scheme on Another reason funds successfully navigated 20 April 2020. the period was that members’ behavioural switching responses were qualitatively Events during 2020 showed that consistent with funds’ expectations – even if funds manage liquidity well, but can on a larger scale – which enabled them to improve some aspects quickly and pre-emptively rebalance their The financial impacts of COVID-19 provided a portfolios towards cash. However, the significant test of super funds’ liquidity magnitude of switching activity exceeded management in March and April. However, funds’ liquidity scenario analyses as it was their liquidity management practices proved much larger than historical episodes. As the to be effective in navigating through these population ages and the superannuation challenging times. system matures, it is reasonable to expect the One reason that funds withstood the scale of member switching activity to challenge of all 3 liquidity risks materialising increase in the future as members become at the same time was that each tended to more alert to the performance of their have the greatest impact on different funds. investments. This could add to the liquidity In particular, member switching activity was challenges associated with funds shifting driven by older investors with larger from an accumulation phase – with total contributions exceeding benefit payments – to a drawdown phase as the superannuation Graph C.5 system matures. Early Release of Superannuation Fund-level releases in 2020, per cent of FUM* Finally, robust liquidity management % % practices and prudential oversight meant that the industry was well placed to 6 6 accommodate this particular liquidity episode. APRA requires funds to maintain a 4 4 ‘Liquidity Management Plan’ (LMP) for each
2 2 investment option. These plans establish the procedures for monitoring and managing
0 0 liquidity on an ongoing basis, including how Individual funds * As at December 2019; captures funds with funds under management funds will manage cash flow using liquid (FUM) greater than $5 billion Sources: APRA; RBA assets (particularly cash) in their default (and
FINANCIAL STABILITY REVIEW – APRIL 2021 51 other) investment options. If liquidity stress management practices. In particular, APRA arises to the extent that it cannot be met by a has called on funds to re-examine their LMPs super fund’s existing resources, they can also in light of the period, ensure they include – as a last resort – refuse to honour member these insights into planning for future events requests to switch investment allocations or and embed the results of their stress tests (with APRA approval) member redemptions. into practice.[6] In addition, funds need to The sophistication of LMPs has strengthened consider the extent to which they rely on considerably since the 2008 financial crisis, as liquidity from certain assets (such as funds worked closely with APRA to ensure sovereign bonds) under stressed market they had suitable plans for both normal times conditions and whether there are alternative and when an idiosyncratic event affects a ways to transact when market depth is fund.[5] reduced. The events of 2020 have also revealed some areas where funds can update their liquidity
Endnotes [1] Over four-fifths of super fund assets in Australia [4] NAB (2019), ‘NAB Superannuation FX Hedging are held in defined contribution funds, which do Survey 2019’, 27 August. not offer guaranteed returns to members. [5] Funds use a number of liquidity management [2] An additional factor that generates liquidity risk at techniques, such as cash-flow monitoring the fund level is the ability of members to quickly procedures, relying on the liquid assets in the rollover between funds. fund’s default option, establishing liquidity [3] While fund-level switching data do not date back valuation policies and incorporating expected to the global financial crisis, research indicates liquidity in their business plans. that the size of member switching flows was small [6] See APRA (2020), ‘Managing Super Fund Liquidity during this period, and not enough to pose in the Midst of COVID-19’ , Insight, Issue 3; and liquidity issues for funds (see Gerrans P (2012), APRA (2020), ‘The Superannuation Early Release ‘Retirement Savings Investment Choices in Scheme: Insights from APRA’s Pandemic Data Response to the Global Financial Crisis: Australian Collection’, Insight, Issue 4. Evidence’, Australian Journal of Management, vol 37(3), pp 415–39).
52 RESERVE BANK OF AUSTRALIA 4. Domestic Regulatory Developments
Coordination between Australia’s main financial Financial institutions have played an important regulatory agencies – the Australian Prudential role in cushioning households and businesses Regulation Authority (APRA), the Australian from the impact of the pandemic, including by Securities and Investments Commission (ASIC), offering temporary loan repayment deferrals. A the Australian Treasury and the Reserve Bank – key focus of the CFR in the latter part of occurs through the Council of Financial 2020 was the expiry of the majority of those Regulators (CFR). The CFR is chaired by the Bank, deferrals in September and October, and which also provides the secretariat. The CFR borrowers’ transition to normal loan repayment remains strongly focused on the effects of the schedules. As noted in ‘Chapter 2: Household pandemic and how the member agencies and and Business Finances in Australia’, lenders and the financial sector can best support the borrowers navigated this period successfully, economic recovery and financial stability. A with almost all borrowers resuming their related focus at recent meetings has been scheduled repayments. The housing and operational risk, in particular cyber risk. The business loans that continue to have deferred improvement of health, economic and financial repayments account for a very small share of conditions in Australia in the second half of outstanding credit. However, they have a 2020 allowed the CFR to return to its regular somewhat riskier profile than other loans, and quarterly meeting schedule, after meeting more careful management will be needed from frequently through much of 2020. lenders, including for any cases of hardship. CFR members are monitoring ongoing develop- The key focus of the CFR has been ments with loans with deferred repayments, recovery from the pandemic … along with the performance of household and Improved economic conditions in Australia have business loans more generally, as support enabled a range of support measures designed measures are further reduced. to sustain households and businesses during Looking ahead, the CFR has noted that social restrictions to be gradually withdrawn. conditions for housing and business lending will This transition has widespread and interlinking be important for shaping the recovery. effects on CFR agencies’ respective areas of Moderate growth in housing credit has almost responsibility. As a result, the CFR has been entirely been for owner-occupier housing and closely monitoring developments, in particular loan commitments have increased strongly, as they relate to loan repayment deferrals, credit consistent with most other indicators of housing conditions and business insolvencies, and their market activity. Mortgage lending standards are implications for economic and financial largely unchanged, but there has been some conditions more broadly. unwinding of the slight tightening in lending conditions early in the pandemic. The CFR
FINANCIAL STABILITY REVIEW – APRIL 2021 53 places a high emphasis on lending standards Questions over the application of business remaining sound, particularly in an environment interruption insurance policies to business of rising housing prices and low interest rates. shutdowns during the pandemic have been a The CFR will continue to closely monitor source of uncertainty for both insurers and developments and has indicated that it will pandemic-affected businesses. The CFR has consider possible responses if financial risks regularly discussed progress on clarifying the increase. validity of claims on these policies. In November Growth in lending to business has been weak 2020, the New South Wales Court of Appeal since the initial drawdown of credit lines by ruled in favour of policyholders in a key test case some businesses in the early stages of the related to exclusions that reference the repealed pandemic. Both demand and supply factors, Quarantine Act 1908. The Insurance Council of including as a result of uncertainty about the Australia has sought special leave to appeal the health and economic outlook, have been at play. decision to the High Court. In consultation with However, with signs that demand for lending is the Australian Financial Complaints Authority, increasing with the improvement in the outlook five general insurers have now also filed a for the economy, the CFR has emphasised the second test case in the Federal Court of Australia importance of businesses continuing to have to test further pandemic coverage issues. As access to finance on reasonable terms. discussed in ‘Chapter 3: The Australian Financial System’, a number of insurers have increased Another area of transition monitored by the CFR provisions for potential payouts. The CFR has has been business insolvencies. Temporary welcomed the commitment of general insurers insolvency relief measures operated between to abide by the terms of agreed test case March and December 2020 to limit viable protocols. This includes not relying on any policy businesses falling into external administration time limits for lodging claims and not avoiding during the pandemic. In conjunction with other liability where the policy holder is insolvent, business support measures, these resulted in where claims are affected by the need to await business insolvencies throughout 2020 being the outcome of the test cases. CFR members markedly lower than in previous years. A have encouraged the industry to promptly pay moderate level of insolvencies is to be expected out valid claims. in a healthy, dynamic economy and so insolvencies are expected to pick up during The CFR regularly reviews developments in non- 2021. A smooth and efficient insolvency process bank financial intermediation and discussed is therefore important to minimise the developments at its November meeting. The disruption of an insolvency to other businesses. disruption to financial markets during the early With this in mind, permanent small business stages of the pandemic meant that non-bank insolvency reforms came into effect from lenders, which rely heavily on securitisation, January 2021, including new debt restructuring slowed their lending for a period. Funding has and simplified liquidation processes. In addition, since improved, including through support from a new class of professional registered liquidator the government’s Structured Finance Support has been introduced to undertake the simplified Fund, operated by the Australian Office of small business debt-restructuring process. CFR Financial Management. The fund has made members discussed the implementation of the targeted investments in term securitisations and new framework and will continue to track its warehouse facilities to support funding markets operation closely in the period ahead. used by non-bank lenders. More generally, the Reserve Bank’s monetary policy actions have
54 RESERVE BANK OF AUSTRALIA reduced funding costs, including for non-bank positive security obligation on financial sector lenders. Non-bank lending remains a relatively entities and additional obligations on entities small share of the Australian financial sector, that are considered to be of national with debt-related assets of non-bank financial significance. The regime is intended to rely on institutions representing around 7 per cent of existing regulatory frameworks to the extent overall financial system assets. possible, to reduce regulatory burden and minimise duplication of requirements. A bill that … but cyber and other operational risks would enable the reforms is currently before the remain very important Australian Parliament. Outside pandemic-related developments, the The CFR endorsed a new cyber work plan in major focus of the CFR has been operational risk, November. This has three elements: developing including cyber risk. In addition to the CFR’s inter-agency incident communication and ongoing work program on cyber security, recent coordination protocols; standardising agencies’ operational risk discussions have reflected two approaches to the regulation and supervision of significant incidents affecting the financial sector cyber risks; and implementing the pilot Cyber over recent months. First, as noted in ‘Chapter 3: Operational Resilience Intelligence-led Exercises The Australian Financial System’, a series of (CORIE) testing framework. The CORIE outages affected ASX Limited in November framework was published by the CFR in 2020, disrupting trading and other functions. As December 2020. It will be used to assess cyber co-regulators of ASX, ASIC and the Bank have resilience by subjecting selected financial sector requested that ASX commission an independent entities to ‘ethical hacking’ exercises that mimic expert review of the ASX Trade outage. ASIC is the tactics, techniques and procedures of real- also investigating whether ASX complied with life adversaries. A key objective of CORIE is to its market licence obligations, and is inform regulators of any systemic or institution- undertaking a detailed analysis of the market specific cyber security risks. Similar exercises impact of the incident, including participants’ have been conducted in other jurisdictions, ability to access alternative trading venues. including the United Kingdom (under the CBEST Second, multiple entities experienced external framework), European Union (TIBER-EU) and breaches of file transfer software supplied by Singapore (AASE). Accellion in December 2020 and January 2021. The affected entities included the Reserve Bank The CFR has discussed a range of other of New Zealand (RBNZ) and ASIC (though topics, including stablecoins and e- investigations have shown that there was no conveyancing access to confidential information held by ASIC). The CFR has recently established a working CFR agencies have been in close contact with group to consider the regulation of ‘stablecoins’. the affected entities, including the RBNZ, in Stablecoins are a type of cryptocurrency that order to understand the implications of the aims to maintain a stable value against a breach and any lessons for regulators and specified asset or pool of assets. This may make regulated entities in Australia. them more attractive to hold as a means of CFR agencies have also been working closely payment than other cryptocurrencies. with the Department of Home Affairs on the Stablecoins came to broader prominence in development of the government’s proposal to 2019 with a proposal for a global stablecoin broaden the scope of the ‘critical infrastructure’ (originally called Libra, but now rebranded as regulatory regime. The reforms would place a Diem) by a consortium of technology-focused
FINANCIAL STABILITY REVIEW – APRIL 2021 55 companies, including Facebook. The Swiss- • A working group will examine develop- based Diem Association has more recently ments in crypto-assets and decentralised announced plans to launch single-currency finance (DeFi), and their potential stablecoins intended for use in consumer digital implications for the financial system. wallets. It is applying to be licensed as a • Following discussions earlier in 2020, the CFR payment system by the Swiss Financial Market established a group to engage with the Supervisory Authority (FINMA). While stablecoins government’s Digital Transformation Agency do not currently play a significant role in the and the private sector on digital identity Australian financial system, the new CFR initiatives. working group will consider how they would be CFR agencies continued their engagement with regulated in Australia and whether any gaps in their New Zealand counterparts via the Trans- regulation exist. Tasman Council on Banking Supervision (TTBC). CFR agencies and the Australian Competition The heads and deputies of the seven TTBC and Consumer Commission are also working agencies met in December 2020, discussing the with state and territory land titles offices to Australian and New Zealand fiscal outlooks and consider regulatory arrangements for electronic strategies; international information sharing property conveyancing (e-conveyancing). arrangements in relation to cyber incidents; and Currently, regulation of e-conveyancing focuses the forward work plan of the TTBC. on the preparation and lodgement of documents with land titles offices, but there are The government’s Review of the some gaps related to the payment and financial Australian Payments System will help to settlement aspects of e-conveyancing. The shape the future approach to regulating agencies are developing options to address payments these gaps in the regulatory framework, and will As part of its Digital Business Plan, announced in report back to the CFR with reform options later the 2020–21 Budget, the government has this year. In the meantime, the CFR has launched a review of the governance and encouraged the e-conveyancing industry to regulatory arrangements for the Australian explore the development of a self-regulatory payments system. The aim of the review is to model for the payment and financial settlement ensure that the payments system’s regulatory aspects of e-conveyancing.[1] architecture and governance structure remain Other activities of the CFR and its working capable of achieving their objectives and groups since the last Review have included the supporting continued innovation and following: competition in the market for payment services. • In November, the CFR published the In turn, this should benefit consumers, conclusions of its review of the regulation of businesses and the broader economy. While the stored-value facilities (SVFs). The CFR focus is on regulatory and governance proposed the creation of a graduated structures, the review is also looking more approach to the regulation of providers, broadly at ways to promote competition and balancing innovation and consumer innovation in the payments system. This protection. In response, the government has includes the use and development of the New announced that it will develop a SVF reform Payments Platform, as well as ways to encourage package. the adoption of alternative payment methods by government, businesses and consumers.
56 RESERVE BANK OF AUSTRALIA There were 46 public submissions to the review, • ensuring that the decline, and eventual which are available on the Treasury website. closure, of legacy payment systems (such as In its submission, the Bank noted that the cheques) is carefully managed to support existing regulatory arrangements for the the needs of users while promoting payments system in Australia have worked well; payments system efficiency. they have helped shape a payments system that in most regards is providing high-quality Operational resilience of payment services for Australian consumers, businesses systems is of growing importance and government entities. However, key aspects The Bank’s submission to the government’s of the regulatory architecture have been in place payments system review also highlighted an for more than two decades and numerous increasing focus on the operational resilience of changes have occurred in the payments system retail payment systems given the growing use of over that time or are underway. In this context, electronic payments and the reduction in the the Bank’s submission raised a number of issues, use of cash. Operational outages in retail including in relation to: payments can cause significant disruption to • overcoming the coordination challenges households and businesses, and economic that can hold back systemic innovation in activity more broadly. Data collected by the Bank payment networks from financial institutions show a significant increase in the number and total duration of • ensuring that the scope of regulation is outages to retail payments in recent years appropriate to respond to the increasing (Graph 4.1). range of entities that are now involved in the provision of payment services To promote reliability in retail payments, the Bank has been working with the industry to • ensuring that industry self-regulatory enhance its data collection on incidents and to arrangements support competition and develop a standard set of statistics on the innovation from new players, while reliability of payment services. These statistics appropriately dealing with the risks to other will be publicly disclosed by individual providers payments system participants and users on a quarterly basis. Better and more transparent • exploring whether a specialised licensing information about the reliability of payment and oversight regime for non-bank payment services will raise the profile of this issue among service providers could help promote access and competition while appropriately Graph 4.1 controlling risk Outages in Retail Payments* • clarifying the Bank’s ability to set regulatory hours Total duration hours requirements to promote the financial and 2,000 2,000
operational resilience of payment systems 1,000 1,000 • examining whether there are aspects of the no hours regulatory regime and market practices that Incident statistics 400 6 are currently limiting competition by non- Average duration (RHS) bank participants in the market for cross- 200 3 Total number border payment services and international (LHS) 0 0 money transfers 13 / 14 14 / 15 15 / 16 16 / 17 17 / 18 18 / 19 19 / 20 * Outages reported by banks and other financial institutions that settle retail payments Source: RBA
FINANCIAL STABILITY REVIEW – APRIL 2021 57 financial institutions and their customers, and grow. It therefore proposed clarifying whether enable improved measurement and the regulatory framework would allow the Bank benchmarking of operational performance. or another regulator to impose operational These benefits should encourage improved resilience or security standards on operators or reliability of retail payment services and support participants in retail payment systems. public confidence in these services over the Principles-based regulatory requirements for longer term. important retail payment systems have been The Bank’s submission nonetheless argued that introduced by central banks in a number of in the future there could be a case for regulatory jurisdictions in recent years, including Canada, action to promote the operational resilience and the European Union and the United Kingdom. security of retail payment systems, for example, if system complexity or cyber risks continued to
Endnotes [1] For more on e-conveyancing, see De Freitas G and E Fitzgerald (2021), ‘Property Settlement in RITS’, RBA Bulletin, March, viewed 6 April 2021.
58 RESERVE BANK OF AUSTRALIA Copyright and Disclaimer Notices
Blade Disclaimer The results of these studies are based, in part, on Australian Business Register (ABR) data supplied by the Registrar to the Australian Bureau of Statistics (ABS) under A New Tax System (Australian Business Number) Act 1999 and tax data supplied by the Australian Taxation Office (ATO) to the ABS under the Taxation Adminis- tration Act 1953. These require that such data are only used for the purpose of carrying out functions of the ABS. No individual information collected under the Census and Statistics Act 1905 is provided back to the Registrar or ATO for administrative or regulatory purposes. Any discussion of data limitations or weaknesses is in the context of using the data for statistical purposes, and is not related to the ability of the data to support the ABR or ATO’s core operational requirements. Legislative requirements to ensure privacy and secrecy of this data have been followed. Only people authorised under the Australian Bureau of Statistics Act 1975 have been allowed to view data about any particular firm in conducting these analyses. In accordance with the Census and Statistics Act 1905, results have been confidentialised to ensure that they are not likely to enable identification of a particular person or organisation.
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